Target's Stock Is Undervalued From A Dividend Perspective

| About: Target Corporation (TGT)

Summary

Target recently announced a quarterly dividend of $0.60 per share with an ex-dividend which is on November 14th.

The company has been increasing its dividend for the past 49 years.

The dividend growth model shows you get a stock value of $126 which makes the stock undervalued by about 85% from today's price of $68.23.

A dividend is just one of many ways a company can reward its shareholders by paying them out in cash. The investor can then choose to take the cash and run, reinvest it in the company, or invest it in a different company. After a company has made their net income for the quarter they have the choice of what to do with it and the choices are usually to either plow the money back into the business for other investments or pay some of that money back to the shareholders in the form of a dividend.

Most Recent Dividend Announcement

Target (NYSE:TGT) recently announced a quarterly dividend of $0.60 per share with an ex-dividend which is on November 14th, making the must own date November 11th. This dividend announcement is on par with what was announced the previous quarter. The dividend is going to be payable to owners on December 10 th. The dividend is currently good for a 3.5% yield on today's share price of $68.23. Based on trailing earnings, the dividend is good for a payout ratio of 47% which is pretty good for now. From a cash flow perspective the company has paid $1.4B in dividends over the past twelve months on operating cash flow of $4.5B which is good for a 31% operating cash flow payout ratio.

Potential Future Dividends

The company has been increasing its dividend for the past 49 years. The company is projected to earn $5.32 per share in earnings for next year and if the EPS payout ratio remains the same at 47% then the company should distribute about $2.50 annually starting 2017(or a 4.2% increase). That amount seems pretty sustainable and I do believe the 47% payout ratio is sustainable for the long-term.

Earnings growth projections for the company are pretty mild for a discount retailer with a one year growth rate of 7.5% and five year growth rate of 5.9%. With that said, I believe a 4% increase to the dividend next year would be much better because it would be safer. A 4% increase would constitute an annual dividend of$2.50 for 2017 if it increases the dividend in 2017.

Dividend Valuation

Now let's get to the meat and potatoes, the dividend valuation model to determine a price that the stock should be at based on the dividend alone. Since I just mentioned that the company has been increasing its dividend for the past 49 years we know that it has a pretty long history of increasing it and should continue to increase it going into the future. The dividend growth model equation takes the form of:

Annual Dividend [D]

Rate of Return [R] - Dividend Growth rate [G]

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Where D is equivalent to the current dividend, R is the rate of return desired by the investor, and G is the anticipated growth rate of the dividend. For the D value I'm going to use the existing dividend rate of $2.40.

For the R value I'm going to use 5.9% because it is the long-term earnings growth estimate. For the G value of the equation I'm going to use a dividend growth rate of 4% because I definitely believe the company could increase the dividend by that much at least for the next year to keep investors happy. When you plug and chug all the numbers you get a stock value of $126 which makes the stock undervalued by about 85% from today's price of $68.23. For reference, the 52-week high on the stock was $84.14 during April of this year.

Conclusion

The dividend discount model is just one of many ways to value a company and should be taken into consideration while trying to evaluate a company. Assumptions are always made while using valuation models and I believe I've selected some of the most conservative criteria for the valuation in this article. This valuation model shows the value of the dividend stream and that the stock is undervalued based on the dividend alone. The company has been around for quite some time and can definitely afford to increase the dividend when 2017 comes around.

The company currently trades at a trailing 12-month P/E ratio of 13.25, which is inexpensively priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 12.82 is currently inexpensively priced for the future in terms of the right here, right now. Next year's estimated earnings are $5.32 per share and I'd consider the stock inexpensive until about $80. The 1-year PEG ratio (1.78), which measures the ratio of the price you're currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is fairly priced based on a 1-year EPS growth rate of 7.45%. There are many ways to value a stock; with the dividend, P/E, and PEG methods being a common place to start.

I actually initiated my position in Target in early June and have been pretty upset with the purchase thus far. So far, I'm down 1.8% on an annualized basis, and will only purchase shares while they are below $68, because I believe that is where it offers additional value. I've selected $68 because it is my average purchase price.

I swapped out of Eaton Vance (NYSE:EV) for Target during the 2016 second quarter portfolio change-out because I ended up turning a profit in the name ( 19.4%, or 53% annualized) and wanted to lock in those profits. Since the swap, I have lost out on gains, as Eaton Vance has outperformed the market and Target since the swap. For now, here is a chart to compare how Target and Eaton Vance have done against each other and the S&P 500 since I swapped the names.

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It doesn't look like the trade has worked out from the chart and that is because it is still too short of a holding period. However, I am actually up 1.9% on the name because it has been a short holding period so far. For now I'm going to continue purchases in the name because it is below the level I feel it offers value .

Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!

Disclosure: I am/we are long TGT.

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.