Should You Invest $1,000 in TGT today?

Target (NYSE: TGT) is a passive income powerhouse with more than five decades of annual dividend raises and an enticing 4.8% yield. But even with the high payout, Target has lost investors money over the last five years while the S&P 500 (SNPINDEX: ^GSPC) has more than doubled with dividends included.

Here's why Target is under pressure, and whether the dividend stock is a buy right now.

Image source: Getty Images.

Retail winners and losers

Retailers like Target have been under pressure as consumers tighten spending amid inflation and economic uncertainty. Data from the University of Michigan shows that consumer sentiment is hovering around its lowest level since 2022. Some companies have capitalized on consumer needs by providing products and services consumers want at affordable prices.

For example, Walmart and Costco Wholesale have steadily grown revenue while sustaining good margins despite macro challenges. Target has had some success with promotions and partnerships, but is still seeing an overall decline in foot traffic.

The divergence between Target's stock price and Walmart's and Costco's over the last two to three years illustrates the degree to which investor confidence has weakened for Target relative to these other names.

TGT data by YCharts

Target slashed its guidance in its most recent earnings announcement. The company is now on track for a third consecutive fiscal year of adjusted earnings-per-share (EPS) declines. With Target's sales and earnings falling, investors have understandably grown skeptical of the company's ability to execute. Target has built up a bad track record of overpromising and underdelivering, so it's hard to put too much faith in its guidance.

To Target's credit, management acknowledged the poor results and is focusing on turning the business around rather than appeasing investors. The company plans to leverage efficiency improvements and a revamped product lineup to get customers in stores and return to meaningful sales growth. Target has the tools to pull it off, but the retailer has to manage costs better, align inventory with buyer behavior trends, and limit steep discounts that have crushed its margins in recent years.

Target's dividend is as healthy as ever

Target's flaws are glaring and ongoing, but it would be a mistake to overlook the qualities that could make the stock a good buy in June.

Target's sales and earnings may be ticking down, but it is still a highly profitable business that generates cash flow. In fact, Target's EPS and free cash flow (FCF) per share remain significantly higher than its dividend per share, even though Target has raised its dividend for 53 consecutive years.

TGT Free Cash Flow Per Share data by YCharts

Typically, when a company's stock price tanks and its dividend yield goes up, it's because earnings are declining and the dividend begins to look unaffordable. However, Target is in a unique situation where its dividend is highly affordable despite the stock price being around six-year lows and the yield ballooning.

Another good way of measuring dividend affordability is comparing the FCF yield to the dividend yield. FCF yield takes FCF per share and divides it by the stock price, similar to how dividend yield is dividend per share divided by the stock price. FCF yield basically shows the theoretical dividend a company could pay if it used all of its FCF on dividends. Target's FCF yield is a sky-high 8.2% -- much more than its 4.8% dividend yield. So while the company isn't growing, it is still a very profitable business that is well positioned to grow its dividend.

A balanced buy for dividend income

Investing $1,000 in Target demonstrates a belief in management's ability to turn the company around and leverage Target's strengths rather than expose its weaknesses. The company's main weakness is that it can't compete with Walmart, Costco, or Amazon in terms of price, but it can find a happy medium centered around an enjoyable customer experience at a good value. The Target Circle loyalty program and Target's exclusive and limited-time partnerships will be instrumental in pulling off the turnaround.

In the meantime, investors can rest easy knowing that the dividend is affordable, even with the high yield. A $1,000 investment in Target would produce about $48 in dividend income per year, which is significantly more than the $13 or so you could expect from an S&P 500 index fund.

Add it all up, and Target stands out as a solid buy for value and income investors today.

Should you invest $1,000 in Target right now?

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Costco Wholesale, Target, and Walmart. The Motley Fool has a disclosure policy.