Target: Doubling Your Dividend Yield

| About: Target Corporation (TGT)

Summary

Target currently pays out a solid dividend.

However, some may want to increase this yield even more.

This article highlights a couple of ways you could think about doubling your cash flow stream.

In a recent article I highlighted why Minneapolis-based retailer Target (NYSE:TGT) was in "much better shape." The longer-term investment history of the security has been interesting.

Back in 2001, Target's market capitalization was about $37 billion. Today, now 15 years later, the market cap is just $36 billion. Yet the business is overwhelmingly better off. Earnings-per-share have grown by about 8% per year, the dividend has increased by 17% annually and the number of outstanding shares has declined by almost 40%.

The reason that the market cap has remained stagnant relates to valuation. Shares went from trading hands at ~26 times earnings down to 13 times earnings or thereabouts. And you can see this show up in the dividend yield as well. In 2001 the yield sat at 0.5%, now it's closer to 3.7%.

Those two factors, a lower valuation and much higher starting yield, allow for a lower "investment bar" moving forward. It doesn't mean that success is inevitable, but it does indicate that the hurdle for providing reasonable or better returns is likely much lower.

Suppose you acknowledge these aspects, but you're still looking for something a bit more enticing. Target currently pays a $0.60 quarterly dividend or $2.40 on an annual basis. That's quite solid, but there are ways to increase this cash flow stream. Let's look at two.

Instead of collecting $2.40 per share, perhaps you'd more interested if you could double that to $4.80. If you are not yet a partner with the firm, you could think about this on the purchasing (or agreeing to purchase) side.

As I write this the January 2018 put option for Target with a $62.50 strike price has a bid of $5.20. That means that if you're willing to set aside the funds to purchase 100 shares of Target at a price of $6,250, you'd receive ~$520 (less fees) upfront. Now let's think about the potential outcomes.

If Target's share price remains above $62.50, the option would go unexercised. The funds you set aside would once more be "released" and available to reallocate once more. In addition, you'd still have your upfront option premium of $520 (which may be taxed differently than dividends) equating to an ~8.3% cash flow yield.

The risk here is that shares later return say 20% or 30%, and you're "stuck" with an immediate 8.3% gain. That's a true risk and ought to be considered. However, if you're content with the well above average cash flow stream this scenario could work out well.

If the option is exercised, you'll have 100 shares of Target. Your immediate cash flow is still ~$520, but your total return can be positive or negative depending on the future share price of Target. In this scenario you'd be much better off than someone electing to purchase shares outright today. Your cost basis would be lower and you'd get paid upfront for making your willingness to buy known.

That's on the buying side. You can double Target's current cash flow by being willing to purchase shares at a small discount.

This sort of thing is available on the owning side as well. Here's a look at some available call options for that same January 2018 expiration date:

The first column indicates the strike price or the price at which you'd be willing to sell your Target stake. Next you have the "net" premium (taking the most recent bid less $0.15 for frictional expenses) followed by the cash flow yield that this would represent.

The last two columns show you the "maximum" gain that you could achieve should the option be exercised - with the first one including sale price and option premium only and the second one also adding in dividends along the way.

Here too we can get an approximation of what it would take to "double" Target's cash flow yield for this year. Agreeing to sell at about $72.50 would add $225 per 100 shares, or just under the current payout.

If the option is not exercised, you collect $240+ in regular dividends along with the ~$225 in option premium, for a total cash flow yield of about 7.2%. Especially compared to someone that is simply buying and holding, this "extra" income can supplement your goals nicely.

If the option is exercised, you'd be forced to sell at $72.50. The risk here is that shares could later trade at $80 or $90, and you'd be "stuck" selling at $72.50. However, the consolation prize isn't exactly lackluster. From this point, you'd be looking at a total gain between 15% and 19% in under a year.

Naturally the degree to which this sort of thing may look interesting is going to vary from person to person. If your cost basis is in the mid-$70's, perhaps you'd be less enthused. Alternatively, if just recently purchased shares and you're looking for a solid cash flow component, these agreements can certainly provide that.

Moreover, you're not limited to a single strike price or expiration date. You can increase your immediate cash flow by agreeing to a smaller maximum gain - say collecting a 6% premium today, but agreeing to "cap" your gain at 10% to 14%. Or you could go the other way - for instance, suppose you'd be happy to generate extra income and part with your stake, but only at a price of $80 or above. This alternative is also available to you.

In order to "double your dividend yield" with Target, you could think about it in a couple of ways. If you're looking to buy, you could agree to buy at a ~3.5% lower price and accomplish that sort of cash flow. Actually it'd be a bit better than that: north of 8% today. On the other hand, if you already own shares, you could nearly double the dividend by agreeing to sell at a ~12% higher price. The takeaway is not an exact agreement, but instead recognizing that you're not required to be an idle party in your cash flow ambitions.

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.

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