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Analysts Whiffed on Target Before Its Plunge

- By Dr. Paul Price

Target (TGT), America's second-largest discount retailer, shocked the investment community with a fiscal fourth quarter (ended Jan. 31, 2017) earnings miss. Management also slashed guidance for fiscal 2017 to a midpoint of $4.00 from analyst estimates of about $5.34.

Shares that had fetched above $85 during 2015 and north of $84 last spring opened at $57.41 on Tuesday. CNBC commentators kept busy all day explaining why Target went down and implying that the company faces a bleak future.

From the tone of these experts you'd think they would have known to be bearish on Target prior to the firm's earnings announcement. There were few SELL ratings, though, before Target fell off a cliff on Tuesday with its largest one-day drop in more than 18 years.

Independent research from both Morningstar and Standard & Poor's fell into the neutral camp. Each assigned Target three-star (out of 5) ratings. The former felt present-day fair value was around $71.

S&P's analysts called fair value as precisely $70.40 while holding out a 12-month target price of $74. They liked the high quality and, ironically, Target's low historical volatility.

Coming on TV now, while appearing to have forecast Target's troubles, seems disingenuous.

Is Target a good buy at about $58?

Based on the now-reduced forward estimate, Target is not as cheap as it was at the previous best entry points (green-starred below) of the past decade. Target is also nowhere near the four most obvious "should have sold" moments (red-starred). Those periods saw Target average 20.8x earnings while carrying an average yield of just 1.44%.

At $57.48 Target was available for 14.4 times the already reduced expectations for fiscal 2017. The 60-cent quarterly dividend provides a well-covered 4.18% current yield. That's almost double Target's average yield since 2007. It's also better than most staid utilities are paying.

Many present holders are likely to stay with Target simply for the income. The "dividend growth" crowd might be attracted to Target now for the same reason. Target has a long history of increasing payouts.

After Tuesday's sell-off it appears to be too late to sell Target . A rebound to a more typical valuation supports a 12-month goal of around $61. Total return at that price equals 9.3% including dividends.

That projected return will probably prove too conservative. Target carved out peak prices ranging from $61 to $85 during each of the calendar years 2011 through 2017 year to date.

Visionary option writers were pocketing outstanding long-term put premiums on Tuesday by selling Target January 2019, expiration $50 and $55 puts. Early Tuesday those were trading for $5.30 and $7.50 per share.

"If exercised" prices on those option sales drop to $44.70 ($50 strike minus $5.30 put premium) or $47.50 ($55 strike price less $7.50 premium).

Future share price movements can never be guaranteed. I can say for sure, though, that owning Target at either of those break-even levels would have been a winning proposition 100% of the time during the most recent half-decade.

Target shares have not changed hands for as little as $44.70 since the summer of 2009.

Target earned $3.30 per share in 2009, well below the reduced year-ahead estimate of $4.00. Annual dividends totaled 66 cents per share in 2009 versus today's rate of $2.40.

Ignore the analysts who were dead wrong on TGT pre-announcement and hate it today, after its drop back to a very decent value.

Smart investors know that the best bargains are available only when others are scared.

Consider owning Target outright for reasonable total return. Option savvy traders should accept large premiums for assuming the slight risk of forced purchase of Target shares at extraordinarily low potential entry points.

Disclosure: No positions in Target shares, Short Target January 2019 puts.

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This article first appeared on GuruFocus.