Updated 11/16/2011

Is Target shooting itself in the foot by trying to be more like Wal-Mart -- or is it making up ground on its much bigger rival?

Target's third-quarter earnings, out Wednesday, again showed gains, more evidence that attempts by the champion of "cheap chic" to look more like the chieftain of "just cheap" are paying off for shareholders.

To cope with tough economic times after losing out to Wal-Mart Stores (WMT, news) during the economic slump three years ago, Target (TGT, news) hatched a game plan that makes it more like the most successful retailer on the planet. That would be the one Sam Walton created.

Of course, Target would never describe the strategy that way, and the plan is a work in progress. But we're starting to see signs that it's working. Target has posted sales gains of late, for example, while Wal-Mart's sales have slumped for nine of the past 10 quarters. Wal-Mart reported Tuesday that it broke that string in the third quarter, but profits fell slightly. Target reported Wednesday that third-quarter sales rose 4.3%, with profits up 3.7%.

We'll learn more after the all-important Black Friday results come in later this month.

image: Michael Brush

Michael Brush

The game plan

Boiled down, Target's plan calls for a nationwide rollout of grocery departments along with storewide price cuts. Those are supposed to bring in more customers more often, with Target hoping they then spend enough on more-profitable cheap-chic apparel, household goods and beauty supplies to boost profits.

Some analysts worry that this won't end well. After all, there's little profit in selling groceries, compared with apparel, home furnishings and personal-care goods, the more traditional fare at Target stores. And offering a regular storewide discount, with a 5% off loyalty card, is not necessarily a recipe for boosting profits.

"We think the shares are nearly fully valued as Target transitions into more of a grocery store," says Morningstar analyst Michael Keara. "Target is using the Wal-Mart strategy, but we do not see nearly the same degree of success." Keara has a three-star rating on the stock, essentially a grade of "C."

But drill down, and there's a good case to be made that Target's strategy makes sense. In fact, there's already some evidence that it is working. If the trends continue, the plan could reward investors who buy shares now and have the patience to wait a few years for the plan to pay off.

The key: Customers who come in for low-margin groceries or sign up for the 5% discount have to buy enough extra stuff to offset the hit to margins. Here's why this strategy just might work.

A wake-up call

Target shareholders got a shock during the 2008-2009 economic slump. Consumers are supposed to "expect more, pay less" at Target. But during the slump, shoppers clearly opted for "always low prices" at Wal-Mart, the retail giant's old marketing tagline.

Target sales slumped, and Wal-Mart sales did well. (Throughout this column, I'm referring to sales results for stores open more than a year, because it is a better measure than total sales, which include the impact of store openings and closings.)

Not surprisingly, Wal-Mart investors were rewarded; Target shareholders, not so much. Wal-Mart advanced 18% from the start of 2008 to the end of 2009, but Target shares dropped and wound up going nowhere for those two years.

Emerging from that dust-up, Target has launched two major steps to try to fight back -- and become more like Wal-Mart -- in an ongoing economic environment of cautious consumers and sluggish growth.

Cheap-chic cuisine and the 5% discount

Target is in the midst of rolling out grocery sections in stores to attract more customers, as Wal-Mart has done. (Wal-Mart is now the nation's largest grocer, selling 39% of the country's groceries.)

Target hopes to have grocery sections, called PFresh, in 900 stores by the end of this year. By late 2013, it wants to have about 1,500 stores PFreshed -- nearly all of them. Target currently has about 1,770 stores.

Let's be clear. Target is not trying to match Wal-Mart in food. Target doesn't want to be a grocery supercenter. In a PFresh, there's no in-house bakery and no deli; you'll find only prepackaged bread and deli meats. It's more about convenience than offering a place where a family can do all its weekly grocery shopping, says Howard Davidowitz of Davidowitz & Associates, a retail consulting and investment banking firm in New York.