Stock Bought: TGT

Having already made two purchases for my Roth IRA in November, I did not plan on buying anything else this month. However, Mr. Market came knocking on my door this morning with an opportunity that I decided to jump on.

Today I bought shares of Target Corporation (TGT), operator of over 1,800 retail stores selling general merchandise in the United States and now Canada. Target is generally viewed as a more upscale version of its largest competitor, Wal-Mart Stores (WMT).

Target has achieved satisfactory operating results over the past several years, with 5-year growth rates of 3.0% for revenue and 6.3% for earnings. Recent growth has been slowed by Target's expansion into Canada, where it has encountered some difficulties, but I think the company will overcome these short-term growing pains within a year or two. Target's financial position is decent, with a debt/equity ratio of 91%, debt/cap ratio of 45%, 6.9x interest coverage, and a current ratio of 0.9. Value Line gives the company a financial strength rating of A and a safety rating of 2.

Target has an impressive dividend growth record. The company is a Dividend Champion, having increased its dividend for 46 consecutive years. The 5-year dividend growth rate is 20.5% and the most recent increase was 19.4% in August 2013. With a payout ratio of 41% and stable cash flows, I think the dividend can continue to grow in spite of short-term earnings weakness. The company has also excelled at share repurchases, reducing the number of outstanding shares by about 28% since 2004.

I think TGT is slightly undervalued to fairly valued at the current price. It has a P/E of 15.3 (vs. a 5-year historical average of 13.6), P/S of 0.6 (vs. 0.5), P/B of 2.5 (vs. 2.4), and dividend yield of 2.7% (vs. 1.8%). Note that these numbers have not been updated to reflect the results reported by the company earlier today. Using a Dividend Discount Model with a dividend growth rate of 10% (half of the 5-year historical rate) and a discount rate equal to the current yield plus the dividend growth rate, I calculate a fair value of $70.07. Morningstar gives a fair value of $64.00 and a 3-star rating. S&P Capital IQ gives a fair value of $73.20 and a 4-star rating. The average of those three estimates is $69.09, which implies an 8% margin of safety at my purchase price, hence my conclusion that the stock is slightly undervalued to fairly valued. Today the stock price dropped 3.5% because the company missed earnings and revenue estimates for the latest quarter, but as noted above, I regard this as short-term weakness. Value Line's analyst expects earnings to "ramp up at a solid pace" starting in fiscal 2014 and S&P Capital IQ sees above-average growth from fiscal 2015 onward.

I bought 30 shares of TGT at the price of $63.70 per share (no commission paid due to a free trade -- my last one), giving me a 2.70% yield on cost. At the current dividend rate, I can expect to receive quarterly dividends of $12.90 from this purchase, which will add a total of $51.60 to my annual dividend income. The stock went ex-dividend a few days ago, so I will not receive the next dividend payment. However, my lower cost basis due to today's price dip is equivalent to about 6.5 quarterly dividend payments, which more than compensates for the missed payment. This purchase was made in my Roth IRA using rollover money. Target becomes the 33rd stock in my portfolio and gives me more diversification in the retail sector, where it is approximately equal-weight with my WMT position. My forward 12-month dividend total increases to $3,282.

I am tempted to say that I am done buying stocks for the month, but Mr. Market could surprise me again. In case you are wondering, I noticed the sell-off in PM today and the after-hours sell-off in ROST, both of which are stocks in my portfolio. I already have a fair-sized position in PM, though, and ROST would need to fall further to become attractively valued, so I do not plan on adding to those positions right away.