One of the particular results of the coronavirus pandemic has been the boom in the housing market in the United States. People are spending a lot more time at home, which is increasing their appetite for buying a home.
According to the Federal Reserve Bank of St. Louis, in the third quarter, year-over-year home prices rose at the fastest pace in 45 years. In an environment of rising real estate prices, home improvement companies are thriving. here’s why Lowe’s (NYSE: LOW) and Home deposit (NYSE:HD) are my top two home improvement stocks to buy in 2022.
Lowe’s was experiencing a multi-year revenue growth deceleration before the pandemic pushed sales up 24% in 2021. Management told investors to expect a slight drop in revenue in its 2022 fiscal year.
Still, management thinks Lowe’s operating profit margin will increase by 10 to 30 basis points, even if sales could decline. If it can achieve that feat, it would be four consecutive years that Lowe’s has increased its operating profit margin: from 2019 to 5.6%, to 8.8% in 2020, at a pace of 12.4% in 2021, estimated to be higher in 2022. This has trickled down to net income where earnings per share have compounded at an annual rate of 18.5% over the past ten years.
Lowe’s management says one of the drivers of spending in its stores and on its website is rising home values. Lowe’s could do even better than management’s estimates if house prices continue to rise at record rates in 2022. Additionally, Lowe’s is trading relatively cheap, with a price-to-earnings ratio of 22 and flow free cash of 26.
The pandemic also helped Home Depot sales. The same macroeconomic factors that are driving Lowe’s revenue growth are inevitably driving Home Depot sales.
Indeed, sales have grown at a compound annual rate of 6.9% for The Home Depot over the past decade. While other brick-and-mortar businesses have suffered from competition with e-commerce retailers, Home Depot has held firm. Home improvement retailers like Home Depot and Lowe’s sell bulky, bulky items that are hard to ship. In addition, they sell the products that buyers need very quickly. These qualities help drive people to their stores.
Like Lowe’s, Home Depot generates healthy operating profitability, only better. In fiscal 2018, 2019 and 2020, The Home Depot achieved an operating profit margin of 14.5%, 14.6% and 14.4%, respectively. Strong operating profits have driven earnings per share growth at a compound annual rate of 19.5% over the past decade.
The best performance is already built into Home Depot stock. It trades at a price-to-earnings ratio of 26.7 and a price-to-free cash flow ratio of 35.2. Granted, Home Depot is more expensive than Lowe’s. However, Home Depot is earning that valuation through better revenue growth and operating profit margins.
Either way, Home Depot and Lowe’s are great companies riding the tailwind of rising house prices. That’s what makes it my top home improvement stocks to buy in 2022.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.