When it comes to dividend stocks, Coca-Cola is a model of consistency, having increased its dividend for 62 consecutive years. Coke’s track record of growing dividends, a 3.1% yield, and a recession-resistant business model make it one of the safest passive income plays on the market. But there may be an even better Dividend King to buy now.
Target (NYSE:TGT) has made a real comeback since crashing to a three-year low in early October 2023. But the stock has cooled off recently, falling 13% over the past three months. Here’s why Target isn’t out of the woods yet, why dividend stocks could remain under pressure, and why it’s ultimately worth buying now.
Target has been on a roller coaster ride
The target hit a record high in 2021, as spending on goods increased during the height of the COVID-19 pandemic. Target’s investments in curbside pickup and e-commerce helped the company post a record profit of $6.95 billion in fiscal 2021, despite challenges with in-store shopping.
But Target overestimated demand trends, particularly for discretionary goods. To be successful, retailers must manage inventory effectively and present a product line that resonates with customers. Stocking too little inventory can compromise sales, while having too much inventory or displaying the wrong products can impact profits.
Target reduced its inventory from $12.6 billion in the first quarter of fiscal 2023 to $11.7 billion in the first quarter of fiscal 2024. Its inventory hit an all-time high of $17.1 billion in the third quarter of fiscal 2022 and are now down 26%. from this level.
A combination of deep discounts (including through its Target Circle loyalty program) and leaner operations have helped Target reduce its inventory. The efforts paid off, as Target’s 12-month operating margin improved to 5.3%, up from 3.5% a year ago.
During Target’s first quarter fiscal 2024 earnings call, CFO and COO Michael Fiddelke discussed improving inventory and noted that sales have now outpaced growth stocks over the last five years:
Looking at the first quarter of 2019, total inventory increased about 30% over those five years, while sales in the just-ended quarter were about 39% higher than in 2019 Given that this sales growth was largely driven by an increase in our sales per store, an increase in our inventory turnover is something we expect to see and should be sustainable over time.
Target does a better job stocking high-volume items. During the most recent quarter, the company reduced its out-of-stock rate on its top third of items by 4% compared to the same quarter last year. Maintaining high-quality inventory and stocking high-demand items will be critical for Target to return its operating margin to its pre-pandemic range of 6% to 7%.
Cracks among consumers
Better aligning its inventory with consumer trends was a step in the right direction for Target. But the company remains highly vulnerable to trends in consumer behavior, particularly when it comes to discretionary purchases.
Many retailers have raised prices to offset inflationary pressures. And for a time, the price increases were largely absorbed by the consumer. But there are signs that consumers are scattered, such as record credit card debt, unaffordable housing and weak macroeconomic indicators. On Tuesday, the Commerce Department released weaker-than-expected retail sales data, indicating a possible slowdown in GDP growth.
Broader stock market gains were mainly driven by growth sectors like technology. However, many consumer-facing businesses have been under pressure. The strong performance of the major indexes is somewhat misleading. Less than a quarter of S&P500 components are outperforming the index’s 15% year-to-date gain, highlighting the top-heavy nature of the stock market.
Many companies that rely heavily on consumer spending rather than business-to-business sales (like Target) could continue to underperform the broader market until fundamentals improve. For this reason, Target is only worth considering if you have a long-term time horizon.
Record payout from Target
Fortunately, investors have a strong incentive to hold on to Target during this difficult time. On June 12, Target announced a 1.8% increase in its quarterly dividend, bringing it to $1.12 per share, or $4.48 per year. This is the 53rd consecutive dividend increase and the 228th consecutive dividend paid.
With a forward yield of 3.1% and a history of dividend increases, Target’s dividend is a critical part of the investment thesis. Target has a payout ratio of 49%, which is a healthy level for a cyclical company.
It pays to be patient with Target stock
Target can’t do anything to correct macroeconomic indicators, but it can make the internal improvements needed to prepare for prolonged weakness in consumer spending. Target appears to be on the right track, but some investors may prefer to take a wait-and-see approach to Target to ensure its turnaround is the real deal.
However, Target’s high dividend yield and price-to-earnings (P/E) ratio of just 16 make it a significant source of passive income and a good value, especially compared to the S&P 500, whose P/E ratio was reduced. amounts to more than 28.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool posts and recommends Target. The Motley Fool has a disclosure policy.
Coca-Cola is a rock-solid dividend king, but so is this cheap stock, down 13% over the past 3 months, originally published by The Motley Fool.