A big story over the past two years has been the rise in house prices. Many variables are in play. Tight supply is one. An influx of people moving to more desirable locations is another. But rising interest rates threaten to dampen the housing market. There are even fears that some of the recent gains could be reversed.
This pushed home improvement retailers Residence Deposit (NYSE:HD) and Lowe’s (NYSE: LOW) well below the highs reached at the end of last year. But those fears could give investors an opportunity. Is one of them better than the other? Wall Street thinks so. And these graphs show why.
One is always more expensive than the other
Over the past decade, Wall Street has agreed to pay a higher valuation for Home Depot than for Lowe’s. As the valuation of the overall stock market swung, the two home improvement stores performed an incredibly predictable dance. Resembling the poles of two magnets repelling each other, the price/sales ratios kept their distance.
It is also always more profitable
A good explanation is the profitability of Home Depot. During that decade, its operating margin remained at least one-fifth higher than that of Lowe’s. The company recently warned that profit margins will suffer from increased spending.
Management went so far as to charter its own freighter to avoid the global supply chain. Historically, Lowe’s has spent more on expenses such as sales, marketing, and administrative functions such as human resources and accounting. In 2021, the difference was around just over 2% of sales, roughly the operating margin gap.
Contrary to history, Lowe’s recent update was optimistic. In February, it raised its estimates for the full year of sales and profits.
And he’s in a better position to manage his debt
One area where Lowe’s looks more appealing is the amount of debt it carries relative to Home Depot. It has $30 billion of combined short- and long-term debt on its balance sheet. Home Depot has $45 billion.
But digging a little deeper reveals that Home Depot is in a stronger financial position, generating nearly double earnings before interest and taxes (EBIT). This means that its ratio multiplied by interest earned – the number of times EBIT can cover annual interest payments – is much higher.
He also grew faster
All of this overlooks the one metric that many investors value above all others: growth. Here too, Home Depot wins. Neither company is in hypergrowth mode, and both have benefited greatly during the pandemic from consumers’ willingness to spend on housing. But over the past five and ten years, Loew’s revenue has grown at a slower pace.
Which one pays you the most for owning stocks?
Investors might expect Lowe’s to make up for these perceived shortcomings by paying a higher dividend to shareholders. They would be wrong. Home Depot’s distribution far exceeds that of Lowe’s. It has done so for most of the past decade.
This does not take into account all the ways of returning capital to shareholders. Lowe’s has done a lot more stock buybacks in recent years. In fact, he’s repurchased 17% of outstanding shares in the past three years alone. Home Depot only bought 6%.
Lowe’s also has more room to increase the dividend going forward. It returns less than a quarter of profits to shareholders in the form of dividends. For Home Depot, the number is about four-fifths. Yet both can easily do so for the foreseeable future.
Is the changing of the guard near?
If you’re looking to add one of the big-box home improvement stores to your portfolio, the historical metrics make a compelling argument for Home Depot over Lowe’s. But that could change. A different outlook for 2022 and an aggressive buyout program make Lowe look like the old Home Depot that Wall Street fell in love with.
Both offer investors exposure to an industry at the heart of the American economy. With strong capital return programs, strong margins and manageable debt, there’s no wrong choice. But Home Depot has proven it can perform over time. That’s why I would lean towards him if I had to choose. Of course, there is no rule against buying both.
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