Target (NYSE: TGT) investors have had a lot to cheer about lately, with the stock up more than 50% since hitting a multi-year low last October. There’s reason to believe that lower interest rates could help propel it even higher.
Even if the rally stalls, Target will reward investors with a steady stream of passive income. Target is a Dividend King with over 50 consecutive years of dividend raises. The stock currently yields 2.9% — well above the S&P 500 dividend yield of 1.3%.
Here’s why Target is a top dividend stock to buy now.
Target can benefit from lower interest rates
Target was hit hard by supply chain disruptions and inflationary pressures. It also mismanaged its inventory and did a poor job of predicting consumer purchasing trends. The following chart shows the effect of these industrywide and self-inflicted factors on Target’s results. 2022 and 2023 — in particular — featured sluggish or negative revenue growth and 10-year-low operating margins.
Target has since adjusted its product mix and inventories, and continued to expand its Target Circle loyalty program. But it remains challenged by weak consumer spending, particularly in discretionary categories.
Lower interest rates can spur spending by reducing borrowing costs, encouraging shoppers to buy more discretionary goods in addition to low-margin staples like groceries and household products. Staples are a way for Target to get customers in the door, but its margins depend on people buying the goods they don’t need.
Despite the potential benefits of lower interest rates, it’s worth understanding why the Fed is adjusting its policy. The Fed kept interest rates high to discourage spending and cool inflation. The strategy worked, but unemployment has increased over the last few months. Credit card debt remains at record levels, along with relatively unaffordable housing. The Case-Shiller Home Price Index, which is a benchmark for single-family U.S. home prices, is still up more than 50% in the last five years. Interest rates for 30-year mortgages are down from the highs, but still top 6%.
The key takeaway is that lower interest rates can help drive consumer discretionary spending, but they won’t automatically solve consumer problems overnight.
A high-quality business at a great value
Despite the macroeconomic uncertainty, Target stands out as a compelling buy because it successfully navigated economic downturns and recessions in the past. Raising the dividend every year no matter what the economy is doing is a testament to Target’s strong balance sheet and profitability. Even during the worst of its slowdown in recent years, Target’s leverage ratios and payout ratio never reached concerning levels.
Today, its payout ratio sits at just 45.3%. That’s excellent, because it indicates that less than half of Target’s earnings are going toward its dividend payment. A payout ratio between 50% and 75% is generally considered a healthy range for a quality company.
Target’s forward price-to-earnings (P/E) ratio is slightly higher than its current P/E ratio — indicating that analysts expect earnings to be lower over the next 12 months than in the past 12 months. Despite the slowdown, Target still sports a valuation below historical levels, meaning the stock isn’t overpriced. Target is especially cheap relative to the S&P 500, which has a P/E ratio of 29.8, compared to just 16 for Target.
Target is built to last
When interest rates are high, high-yield savings accounts and certificates of deposit can be more attractive than dividend stocks for investors who are primarily targeting passive income. But when the yield on these products decreases, there’s less opportunity cost for investing in dividend stocks.
While no dividend payment is guaranteed in the stock market, a Dividend King like Target offers an elite level of reliability. The company has a track record for dividend raises, a clear trajectory for future earnings growth, a healthy balance sheet, and a manageable payout.
Investors should watch how Target navigates a lower-interest-rate environment, manages inventory, and what promotions and rewards member deals it devises to encourage potentially higher spending. Another key benchmark is whether the company can continue boosting its operating margin to return to its pre-pandemic range of around 6% to 8%.
Target can benefit from a lower-interest-rate environment, but a change in the economic cycle won’t make or break the investment thesis. That makes it a worthwhile stock to buy and hold for the long term.
Should you invest $1,000 in Target right now?
Before you buy stock in Target, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Target wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you’d have $743,952!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.
*Stock Advisor returns as of September 23, 2024
Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.
The Fed Just Lowered Interest Rates. My Top Dividend King Stock to Buy Now. was originally published by The Motley Fool
Source Agencies
