Earnings

Dissecting the Numbers for Fred’s, Inc. (FRED) and Target Corporation (TGT)

Fred’s, Inc. (NASDAQ:FRED) shares are down more than -72.58% this year and recently decreased -20.04% or -$1.02 to settle at $4.07. Target Corporation (NYSE:TGT), on the other hand, is down -13.89% year to date as of 12/05/2017. It currently trades at $61.20 and has returned 9.86% during the past week.

Fred’s, Inc. (NASDAQ:FRED) and Target Corporation (NYSE:TGT) are the two most active stocks in the Discount, Variety Stores industry based on today’s trading volumes. We will compare the two companies based on the strength of various metrics, including growth, profitability, risk, return, and valuation to determine if one is a better investment than the other.

Growth

Companies that can increase earnings at a high compound rate over time are attractive to investors. Comparatively, TGT is expected to grow at a -4.18% annual rate. All else equal, FRED’s higher growth rate would imply a greater potential for capital appreciation.



Profitability and Returns

Growth isn’t very attractive to investors if companies are sacrificing profitability and shareholder returns to achieve that growth. We will use EBITDA margin and Return on Investment (ROI), which control for differences in capital structure between the two companies, to measure profitability and return. EBITDA margin of 9.89% for Target Corporation (TGT). FRED’s ROI is -13.80% while TGT has a ROI of 15.50%. The interpretation is that TGT’s business generates a higher return on investment than FRED’s.

Cash Flow 




Earnings don’t always accurately reflect the amount of cash that a company brings in. FRED’s free cash flow (“FCF”) per share for the trailing twelve months was +0.34. Comparatively, TGT’s free cash flow per share was +0.70. On a percent-of-sales basis, FRED’s free cash flow was 0.61% while TGT converted 0.55% of its revenues into cash flow. This means that, for a given level of sales, FRED is able to generate more free cash flow for investors.

Liquidity and Financial Risk

Liquidity and leverage ratios are important because they reveal the financial health of a company. FRED has a current ratio of 1.90 compared to 1.00 for TGT. This means that FRED can more easily cover its most immediate liabilities over the next twelve months. FRED’s debt-to-equity ratio is 0.51 versus a D/E of 1.13 for TGT. TGT is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

FRED trades at a P/B of 0.70, and a P/S of 0.09, compared to a forward P/E of 14.69, a P/B of 3.04, and a P/S of 0.50 for TGT. FRED is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. FRED is currently priced at a -46.94% to its one-year price target of 7.67. Comparatively, TGT is 4.37% relative to its price target of 58.64. This suggests that FRED is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.50 for FRED and 3.00 for TGT, which implies that analysts are more bullish on the outlook for TGT.

Risk and Volatility

Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. FRED has a beta of 1.80 and TGT’s beta is 0.63. TGT’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Comparing the number of shares sold short to the float is a method analysts often use to get a reading on investor sentiment. FRED has a short ratio of 18.31 compared to a short interest of 7.27 for TGT. This implies that the market is currently less bearish on the outlook for TGT.

Summary

Fred’s, Inc. (NASDAQ:FRED) beats Target Corporation (NYSE:TGT) on a total of 9 of the 14 factors compared between the two stocks. FRED is growing fastly, has a higher cash conversion rate, higher liquidity and has lower financial risk. In terms of valuation, FRED is the cheaper of the two stocks on an earnings, book value and sales basis, FRED is more undervalued relative to its price target. Finally, BIG has better sentiment signals based on short interest.

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