Week 2 - Discussion Forum 1
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This week, I will leverage Target's financial data for a comprehensive analysis. The goal is to gain a better insight into Target's financial well-being, focusing on key dividend metrics, the required rate of return, and the P/E ratio. These aspects collectively play a crucial role in assessing the company's investment appeal and its positioning in the market.
As of January 2, 2024, Target Corporation's latest stock price is P
p
=$143.10. Over the course of the preceding year, the company has disbursed a cumulative dividend amounting to D
p
=$4.36, according to information obtained from Target Corporation (n.d.) and Mergent Online (2023a)
Calculate the current dividend yield on the stock.
To calculate the current dividend yield on the stock, use the following formula:
Dividend Yield =Annual Dividend per Share/ Current Stock Price
Dividend Yield = $4.36/143.10 = 3.05%
Calculate the required rate of return (Ke) for an investment in the common stock. You should use formula 10-9 in the textbook to do this calculation and use an assumed growth rate of 5%.
To calculate the required rate of return (
Ke
) for an investment in the common stock using the Gordon Growth Model (formula 10-9 in the textbook), where g
is the assumed growth rate of 5%.
Ke =D1/P
0
+g
Ke = 4.36/143.10 +0.05 = 8.05%
Identify the current P/E ratio for the company from a source such as Yahoo! Finance or Barron’s.
The P/E ratio is calculated as the current stock price divided by the earnings per share (EPS). According to Mergent Online (n.d.), last year’s earnings per share (EPS) was 7.88.
P/E ratio = $143.10/7.88
P/E ratio = 18.16
The relationship between dividend yield and Ke
is crucial. A higher required rate of return (
Ke
) compared to the dividend yield may suggest that investors expect greater returns than the company currently provides in dividends. This could indicate perceived risk or uncertainty in the
company's future performance (Ross et al., 2019).
The relationship between the P/E ratio and Ke
is complicated. A high P/E ratio indicates that the market is willing to pay a premium for the company's earnings, possibly reflecting positive
expectations about future growth. However, if the Ke
is significantly lower than the P/E ratio, it may suggest that the market anticipates a higher growth rate than assumed in the Ke
calculation. This can indicate supposed low-risk or optimistic future cash flows, as Brealey et al. (2017) suggested.
According to Mergent Online (2023b), The earnings per share (EPS) for two other companies in the same industry, Walmart and BJ’s, were 6.03 and 3.81, respectively. The P/E ratio for Walmart and BJ’s can be determined as follows :
Walmart current stock price = $159.29 (Walmart, 2024)
BJ’s current stock price = $67.32 (BJ’s, 2024)
Walmart P/E = 159.29/6.03 = 24.42
BJ’s P/E = 67.32/3.81 = 17.67
Based on the findings, Target is doing slightly better than BJ’s, but Investors would favor Walmart over Target and BJ’s since it has a greater P/E ratio, Brealey et al. (2017) noted.
According to Brealey et al. (2017), a lower required rate of return (
Ke
) is often associated with higher valuations, reflected in a higher Price-to-Earnings (P/E) ratio. Investors are willing to accept a lower rate of return when they perceive less risk or anticipate higher growth. Therefore, in the context of P/E comparisons, the company with the lowest Ke
will likely have the highest P/E ratio.
The connection between a company's growth rate, its required rate of return (
Ke
), and its value, often explained through the Gordon Growth Model, demonstrates the inverse relationship between the required rate of return and the stock price. (Ross et al., 2019; Block et al., 2022).
References
Block, S. B., Hirt, G. A., & Danielson, B. R. (2022). Foundations of financial management (18th ed.).
Target Corporation. (n.d). About us. https://corporate.target.com/about
Mergent Online. (2023a). Target Corp (NYS: TGT) https://www.mergentonline.com/companydetail.php?pagetype=highlights&compnumber=2355
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2019). Fundamentals of corporate finance. McGraw-Hill Education.
Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of corporate finance. McGraw-Hill Education.
Mergent Online. 2023b). Walmart, Target and BJ’s Pricing Information https://www.mergentonline.com/buildfiles.php?
fileName=MCR_20240102220709_15794772796594cf5d6f201.html
Walmart. (2024). Investor relations.
https://stock.walmart.com/home/default.aspx
BJ’s. (2024). Investor relations. https://investors.bjs.com/home/default.aspx
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