Target (NYSE:TGT) is growing more quickly than rival Walmart (NYSE:WMT) and sports better profit margins than Costco Wholesale (NASDAQ:COST). Yet, Target stock is valued like a utility holding, while the shares of Costco and Walmart are priced as if they were top-tier technology names. That doesn’t seem to be fair.
The explanation isn’t all that elusive, although the market may not even consciously realize why it’s keeping Target stock in check.
Stuck in the Middle
The price-earnings ratios of Target stock are lower than Costco and Walmart because shares of Walmart are less volatile, while Costco is growing much more rapidly than TGT and Walmart. Both Walmart and Costco also have delivered more consistent results.
Target, in short, isn’t reliable enough for Target stock to command a premium.
The table below tells the tale, as it compares each company’s trailing and forward-looking P/E ratios to each stock’s “beta,'” which measures volatility compared to the S&P 500. The number of earnings misses of each outfit over the course of the past three years also suggests investors aren’t interested in paying up for names that run the risk of coming up short on quarterly earnings, unless they offer a compelling reason to do so. Costco fits in the latter category because its sales regularly jump 7% year-over-year. Given that pace, investors will tolerate an occasional earnings miss by COST.
As you can see, margins aren’t an important determinant of stock price in this sector, Target has usually had the highest margins of the three companies, but that advantage has not been reflected in TGT stock in a long, long time. The other criteria simply are more important.
The X-Factor
That being said, even if all of Target’s relevant numbers were more competitive with those of WMT and COST, there’s little assurance that the valuation of Target stock would be higher.
That’s because TGT has a perception problem. Not only do investors assume its smaller size prevents it from competing effectively against Walmart, Costco and Amazon.com (NASDAQ:AMZN), but the retailer has stumbled into at least one too many gaffes that keep investors — as well as shoppers — suspicious about it.
For instance, the echoes of the 2013 data breach that exposed the credit-card information of 41 million Target customers are still ringing. Indeed, the volume of those echoes was turned up again in mid-June when TGT struggled to ring customers up at its cash registers for an entire weekend. It wasn’t a data breach, but it was a reminder that the company’s technology may be fatally flawed.
Then there’s the 2016 decision to permit transgender individuals to use the bathroom and fitting room of their choice, resulting in a boycott that’s still underway. Even before that dust has fully settled, the company kicked it up again just a few days ago by officially telling new mothers to “nurse wherever and whenever you like.”
In both cases, controversy could have been averted by refraining from announcing an official policy.
By permitting each store to handle such delicate matters on a case-by-case basis, Target could have steered clear of public and media scrutiny. By bringing sensitive matters front and center– something Costco and Walmart mostly haven’t done — Target set the stage for backlashes. Such controversies makes Target stock less appealing to investors.
The Bottom Line on Target Stock
The great irony in all of this is that Target continues to perform on par with its rivals. The issue is entirely TGT stock and how much investors are willing or unwilling to pay for it.
But investors’ reticence about Target stock has still been enough to suppress the shares in a way that’s proven frustrating.
Don’t expect things to change in the foreseeable future. The volatility of TGT stock that’s keeping its P/E ratio in the teens is being caused by the same investors who are in a position to fix it. If those investors haven’t yet gotten past the fact that the retailer has embraced the idea of being in the political and cultural fray, it’s unlikely they will anytime soon. Likewise, if they don’t yet care about superior margins, they’re not going to care about them going forward.
In other words, fair or not, Target stock isn’t likely to be seen as undervalued and ripe for substantially higher prices anytime in the foreseeable future.
As of this writing, James Brumley held no position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
