I'm delving into a pairs trading strategy featuring two powerhouses in the retail industry: Target Corporation (TGT) and Gap Inc. (GPS). Both companies are well-recognized and have an extensive product range, but there are key differences that open up a trading opportunity. I'm considering going long on Target and short on Gap, aiming to capitalize on their reversion to a historical relationship.
Why Go Long on Target Corporation (TGT):
Valuation: Target has a lower P/E ratio of 15.17 compared to Gap's 36.54, making Target comparatively less expensive.
Dividend Yield: Target offers a dividend yield of 3.63%, which while lower than Gap's 5.57%, comes with stronger fundamentals like higher ROA and ROE.
Profitability: Target’s ROA and ROE are 6.38% and 29.87% respectively, much higher than Gap’s ROA of 0.94% and ROE of 4.73%.
Performance Metrics: Despite Target's negative performance over the last year, its stronger fundamentals could make it a strong candidate for a rebound.
Why Short Gap Inc. (GPS):
Valuation: Gap's P/E ratio of 36.54 suggests that it might be overvalued compared to Target.
Short Interest: Gap has a high short float of 18.32%, which could mean it is more vulnerable to negative market sentiment, making it a candidate for a short position.
Profitability: Gap’s lower ROA and ROE figures as compared to Target suggest less efficiency and profitability, reinforcing the decision to short the stock.
Performance Metrics: Despite positive performance in the short term, Gap's weaker fundamentals compared to Target make it less appealing for a long-term position.
Decision:
Long on 1 TGT
Short on 10 GPS
Why Go Long on Target Corporation (TGT):
Valuation: Target has a lower P/E ratio of 15.17 compared to Gap's 36.54, making Target comparatively less expensive.
Dividend Yield: Target offers a dividend yield of 3.63%, which while lower than Gap's 5.57%, comes with stronger fundamentals like higher ROA and ROE.
Profitability: Target’s ROA and ROE are 6.38% and 29.87% respectively, much higher than Gap’s ROA of 0.94% and ROE of 4.73%.
Performance Metrics: Despite Target's negative performance over the last year, its stronger fundamentals could make it a strong candidate for a rebound.
Why Short Gap Inc. (GPS):
Valuation: Gap's P/E ratio of 36.54 suggests that it might be overvalued compared to Target.
Short Interest: Gap has a high short float of 18.32%, which could mean it is more vulnerable to negative market sentiment, making it a candidate for a short position.
Profitability: Gap’s lower ROA and ROE figures as compared to Target suggest less efficiency and profitability, reinforcing the decision to short the stock.
Performance Metrics: Despite positive performance in the short term, Gap's weaker fundamentals compared to Target make it less appealing for a long-term position.
Decision:
Long on 1 TGT
Short on 10 GPS