If you wanted to make a strong bullish case for an intermediate to long-term investment in Target (NYSE:TGT) it wouldn't be that difficult. Here I'll show you.
Last year Target reported GAAP earnings per share of $5.25 or adjusted earnings of $4.69 per share. Depending on where you look, analysts are expecting this year's earnings per share to be in the $5.10 to $5.30 range, with intermediate-term growth of over 9% per annum. After five years this is the sort of thing that could equate to earnings per share of $7.35 or so.
Over the past decade, shares of Target have exchanged hands with an average earnings multiple of about 16. If this were to hold in the future, you'd anticipate a future share price near $118 after half a decade. Naturally the actual results could be much better or worse, but I don't believe that's an especially ambitious set of assumptions for a hypothetical "bull" case.
Target's current quarterly dividend payment sits at $0.60. Should the dividend payment also grow by 9% per annum, this would result in the expectation of receiving just over $14 in cash payouts over the five-year period.
In total you might anticipate a share of Target offering $132 or so in total value (prior to thinking about reinvestment) under those assumptions. Expressed differently, this set of presumptions implies the possibility of a total return on the magnitude of 14.5% per annum. As a point of reference, that's the sort of thing that would turn a $10,000 starting investment into $20,000 after half a decade.
That's how I'd think about a reasonably upbeat scenario for Target. Now two notes should be made. First, although the returns would be more than solid, the above set of assumptions isn't even at the upper echelon of what it could be. You could assume, say 12% growth and a future P/E ratio of 20 for an even greater result.
Second, naturally this is only one scenario out of many. In order to take in a more complete view, you might discount some of the above assumptions to create a "base" case. For instance, instead of 9% annual earnings per share growth you could use 6%. And instead of presuming that shares ought to trade at 16 times earnings, you could use 15.
These seemingly small changes can have a large impact on your expected return. (And for more detail as to how you might come up with these types of assumptions, here's an article focused specifically on that subject.) In this scenario, your anticipated return drops down to 10.8% per annum. That's still rather solid, but a far cry from nearly 15% yearly gains.
Finally, we could look at "slow growth" case, using say 3% annual earnings per share growth and a future earnings multiple of 14. In this scenario, your anticipated return would decrease to 7.2% - effectively half the rate of the "bull" case. Here's a summary of the three different scenarios that I detailed above:
Just for fun I added a fourth column titled "zero" - which shows the potential returns that could be generated should the earnings and dividend payment remain the same. Granted all four scenarios start out assuming earnings per share climb above $5 for the first year, but this is what is anticipated and we're already half way there.
This table does a nice job of detailing how you might feel about the security at present. Naturally there are unlimited possibilities, but I would suggest that these four possibilities cover quite a bit of ground. On the positive side, you could think up even better scenarios like "euphoric" that would result in even better returns. On the negative side, you could suppose that Target the business will start declining and won't recover. Given that we're working with guesses about the future, your conclusion will be largely based on your assumptions for the business.
I find two interesting notes when I look at this table. The first thing is that Target doesn't have to do anything that spectacular to offer reasonable returns. As a result of the well above average dividend yield and reasonable valuation, even 3% annual growth can turn in respectable returns.
The second item of note is that this illustration demonstrates why pricing matters. In April of this year, shares of Target reached $84 before declining dramatically to today's number closer to $67. And to be sure part of this is in response to potential challenges. However, the much lower share price also makes up for a lot of that.
Just to quantify it a bit, here's a look at the anticipated annual returns for Target using the same assumptions but different price points:
It should be noted that the total return described is "total anticipated annual return." This comparison details why shares of Target are looking much more attractive. With the share price in the mid-$80s, you had to presume that Target would be able to grow by 6% to 9% to justify a solid investment.
With a price in the $60s, the anticipated growth doesn't have to be nearly as high. Even if Target were "only" able to grow by 0% to 3%, today's price still allows for reasonable expected returns. Target's business may very well be more challenged today than it was a couple of months ago (or not, depending on your previous long-term view), but the decrease in share price has more than made up for this.
Today shares of Target look much more attractive for one basic reason: the share price is materially lower than it was. It is true that the expectations for business improvement may now be lower as well, but I would contend not to the same extent as the decline in the share price. As a result, you now have a well above average dividend yield and reasonable valuation that dramatically lower the investment bar.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.