After a promising January, the banking sector’s turbulence has shook the markets and caused them to retreat. It’s an unpleasant sight for Target shareholders (TGT, 2.44 percent); The stock had a rough 2022 and is now nearly 40% below its high.
But is Target’s decline an example of throwing away the baby with the bathwater? Or do investors have good reasons to dislike the stock? What you need to know is as follows:
In 2022, Target fell short of expectations. Sadly, Target’s decline was not all smoke and mirrors. Throughout the year, the company struggled with squeezed profit margins. The chart shows how operating margins fell significantly from long-term averages. Operating income in 2022 decreased 57% year-over-year, falling $5.1 billion from $8.9 billion in 2021 due to lower margins.
Why then? As consumer spending declined,
Target’s fulfillment costs skyrocketed as a result of rising freight and supply chain costs, as well as investments in fulfillment centers and employee compensation. When everything is added up, earnings per share (EPS) are reduced by half; On a non-GAAP (generally accepted accounting principles) basis, Target earned $6.02 in 2022, down from $13.56 in 2021.
Putting things in perspective in that context; If earnings are cut as well, it seems fair that a stock price is cut in half. The stock has a price-to-earnings ratio (P/E) of 26.8, based on $6.02 in 2022 earnings, which is still 44% higher than the stock’s long-term average P/E of 18.5.
Is 2023 a better year?
This year, management anticipates improved operating conditions and an additional $1 billion in operating income. The current range of EPS guidance for 2023 is $7.75 to $8.75, which reflects the economic uncertainty.
I will make the hypothetical assumption that Target achieves a $9 EPS beat. The stock continues to trade at a forward P/E of 17.8, which is roughly in line with its long-term average. To put it another way, investors could wait another year for the company to grow to the point where its current valuation makes sense.
Analysts, on the other hand, aren’t quite as upbeat about Target’s prospects. Since long-term EPS growth estimates have faltered, they now predict a slight decline in earnings.
Might examiners at any point be off-base? Sure enough! If Target’s operating performance continues to deteriorate, investors run the risk of seeing shares fall below the company’s long-term average. That could mean a longer period of time before the company’s dividend, which pays out 2.7% at the current share price, provides any meaningful investment return.
What are investors’ options?
If an investor can identify the root of the problem and correctly predict a turnaround, a struggling company can be a great investment. Target’s difficulties are well-known, and it is reasonable to anticipate that management will eventually correct the ship.
Even though shares have dropped 40%, the issue is that the stock’s valuation does not yet reflect all of the possible outcomes. Investors looking to purchase shares should exercise extreme caution or wait until management exhibits clear uptrends in operating margin and earnings growth for a few quarters.
