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Better Buy: Costco vs. Target

Joe Tenebruso, The Motley Fool

Costco Wholesale (NASDAQ: COST) and Target (NYSE: TGT) have proven that it's possible for retailers not just to survive in the age of e-commerce but to thrive. In the process, they've delivered strong returns to shareholders, with their stocks up 38% and 33%, respectively, so far in 2019.

But which of these retail titans' stock is the better buy today? Let's find out.

A digital shopping cart.

Image source: Getty Images.

Competitive strategy

Costco's competitive advantages are derived from two core strengths: its membership model and massive scale. For as little as $60 per year, Costco's members gain access to the warehouse chain's discount-filled stores. By relying on its membership fees to fuel its profit growth, Costco is able to price its wares aggressively. Moreover, the company's large store base gives it a buying-power advantage over many of its rivals, thereby allowing it to price its goods lower than its competitors can match. And by constantly rotating its selection, it creates a treasure hunt-type shopping experience that helps to drive traffic to its stores.

Target, meanwhile, tends to price its goods slightly higher than competitors such as Costco and Walmart. It focuses more on delivering a higher-end shopping experience and offering exclusive brands within its stores. Target is also investing aggressively in its omnichannel initiatives. By using its stores as fulfillment hubs for its e-commerce operations, Target is able to offer fast shipping options to its customers, including same-day delivery in many areas. In turn, Target is enjoying strong digital sales growth that has exceeded that of e-commerce giants Amazon and Walmart in recent quarters.

All told, Costco arguably has a superior in-store competitive strategy, while Target has an advantage in terms of e-commerce. I'm going to call it a draw here.

Advantage: None

Financial strength

Let's now compare some key financial metrics for these two retail giants.

Metric

Costco Wholesale

Target

Revenue

$149.6 billion

$76.2 billion

Operating income

$4.7 billion

$4.2 billion

Net income

$3.6 billion

$3.0 billion

Operating cash flow

$5.6 billion

$5.8 billion

Free cash flow

$2.6 billion

$2.4 billion

Cash & investments

$8.2 billion

$1.2 billion

Debt

$6.5 billion

$12.4 billion

Data sources: Morningstar, company filings.

Costco and Target produce similar levels of profit and cash flow, despite the fact that Costco generates twice as much revenue. However, Costco has a much stronger balance sheet, with $1.7 billion in net cash compared to more than $11 billion in net debt for Target. That gives Costco the edge here.

Advantage: Costco

Growth

Wall Street expects Target to grow its revenue by less than 4% annually in 2019 and 2020. Additionally, analysts project that Target's earnings per share will increase by 8.4% annually over the next five years, fueled by its omnichannel initiatives.

Meanwhile, Costco's sales are expected to rise by more than 7% annually over the next two years. Moreover, its earnings are forecasted to increase by slightly more than 10% annually over the next half decade, driven by new store openings and strong comparable-store sales growth.

As such, Costco has a slight edge in terms of projected growth in the coming years.

Advantage: Costco

Price

Finally, let's review some common stock valuation metrics.

Ratio

Costco Wholesale

Target

Price-to-sales

0.83

0.59

Price-to-free cash flow

47.62

18.79

Trailing price-to-earnings

34.59

15.40

Forward price-to-earnings

32.93

13.95

Price-to-earnings-to-growth

3.49

1.79

Data source: Yahoo! Finance.

Whether we base it on sales, cash flow, or earnings, Costco's stock is substantially more expensive than Target's. This is true even if we account for Costco's higher projected profit growth, as we do with the price-to-earnings-to-growth (PEG) ratio. Clearly, Target's shares are more attractively priced.

Advantage: Target

The better buy is...

I tend to recommend the company that comes out ahead in the majority of these categories. And Costco does have a stronger balance sheet and a slightly higher expected growth rate, giving it a 2-to-1 advantage over Target (Costco leads in financial strength and growth while Target comes out ahead only in terms of price). But with its shares priced at such a drastic discount to those of Costco, I'd argue that Target's stock is the better buy today.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has the following options: short January 2020 $180 calls on Costco Wholesale and long January 2020 $115 calls on Costco Wholesale. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.