Coca-Cola Is a Rock-Solid Dividend King, but So Is This Dirt Cheap Stock That’s Down 13% in the Past 3 Months | The Motley Fool

When it comes to dividend stocks, Coca-Cola is a model of consistency, having raised its dividend for 62 consecutive years. Coke’s track record for dividend raises, 3.1% yield, and recession-resistant business model make it one of the safest passive income plays out there. But there may be an even better Dividend King to buy now.

Target (TGT 1.92%) has staged quite a comeback since collapsing to a three-year low in early October 2023. But the stock has cooled off recently, falling 13% in the past three months. Here’s why Target isn’t out of the woods yet, why the dividend stock could remain under pressure, and why it is ultimately worth buying now.

Target has been on a roller-coaster ride

Target reached an all-time high in 2021 as goods spending surged during the worst of the COVID-19 pandemic. Target’s investments in curbside pickup and e-commerce helped the company post an all-time high profit of $6.95 billion in fiscal 2021 despite challenges with in-store shopping.

But Target overestimated demand trends, especially on discretionary goods. For retailers to succeed, they must effectively manage inventory and present a product mix that resonates with customers. Stocking too little inventory can leave sales on the table while having too much inventory or featuring the wrong products can impact profits.

Target has 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 reached an all-time high of $17.1 billion in the third quarter of fiscal 2022 and is now down 26% from that level.

A combination of steep discounts (especially through its Target Circle loyalty program) and leaner operations have helped Target work down its inventory. The efforts have paid off, as Target’s trailing-12-month operating margin has improved to 5.3% — up from 3.5% a year ago.

On Target’s first-quarter fiscal 2024 earnings call, CFO and COO Michael Fiddelke discussed inventory improvements and noted that sales have now outpaced inventory growth over the last five years:

When we look back to the first quarter of 2019, total inventory has increased about 30% over those five years, while sales in the quarter just ended were about 39% higher than in 2019. Given that this growth in sales was largely driven by an increase in our sales per store, an increase in our inventory turns is something we’d expect to see and something that should be sustainable over time.

Target is doing a better job stocking high-volume items. In the recent quarter, it reduced its out-of-stock rate on its top one-third of items by 4% compared to the same quarter last year. Maintaining a high-quality inventory and stocking high-demand items will be critical for Target to get its operating margin back up to its pre-pandemic range of 6% to 7%.

Cracks in the consumer

Better aligning its inventory with consumer trends was a step in the right direction for Target. But the company is still heavily vulnerable to consumer behavior trends, particularly on discretionary purchases.

Many retailers increased prices to offset inflationary pressures. And for a while, price increases were largely absorbed by the consumer. But there are signs that consumers are spread thin, such as record high credit card debt, unaffordable housing, and weak macroeconomic indicators. On Tuesday, the Commerce Department reported weaker-than-expected retail sales data, indicating GDP growth could be slowing.

Broader stock market gains have been primarily driven by growth sectors like technology. However, many consumer-facing companies have been under pressure. The strong performance of the major indices is a bit misleading. Less than a quarter of S&P 500 components are outperforming the index’s 15% year-to-date gain — highlighting the stock market’s top-heavy nature.

Many companies that depend heavily on consumer spending rather than business-to-business sales (like Target) could continue underperforming the broader market until the fundamentals improve. For that reason, Target is only worth considering if you have a long-term time horizon.

Target’s record payout

Thankfully, investors are getting a sizable incentive to hold Target through this challenging time. On June 12, Target announced a 1.8% increase to its quarterly dividend — boosting the payout to $1.12 per share or $4.48 per year. It marked the 53rd consecutive dividend raise and the 228th consecutive dividend paid.

With a forward yield of 3.1% and a track record of dividend increases, Target’s dividend is a core 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

There’s nothing Target can do to fix macroeconomic indicators, but it can make the internal improvements necessary to prepare for prolonged weak consumer spending. Target seems to be on the right track, but some investors may prefer to take a wait-and-see approach to Target to make sure its turnaround is the real deal.

However, Target’s high dividend yield and price-to-earnings (P/E) ratio of merely 16 make it a meaningful source of passive income and a good value — especially compared to the S&P 500, which has seen its P/E ratio rise to more than 28.