Both companies’ results have been hurt by economic forces beyond their control.
Home Depot’s results have held up better than those of its longtime rival.
Both companies’ valuations have become less expensive.
Picking value stocks isn’t easy. That’s because value investing involves buying stocks that you perceive as undervalued. Companies’ stock prices and valuations can fall for any number of reasons. Value investors believe the market has mispriced their prospects, which will result in appreciable gains.
Home Depot (NYSE: HD) trades at a higher share price than Lowe’s Companies (NYSE: LOW), but that doesn’t mean it’s the better value. You’ll need to compare valuations based on a common metric, like price-to-earnings (P/E) ratios, compared to their long-term growth prospects.
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Home Depot and Lowe’s both compete in the home-improvement retail space. The former is the largest company in the sector, generating about $165 billion in annual sales. That’s nearly double competitor Lowe’s $86 billion in sales.
Both companies have high market shares, but their sales are sensitive to macroeconomic conditions. These include home sales, interest rates, the job market, and consumer confidence. Right now, with elevated inflation, home sales and borrowing rates have been affected, and homeowners have put off major renovations.
That explains the companies’ tepid sales growth. However, Home Depot seems to be doing better. The company’s fiscal second-quarter (ended Aug. 2) same-store sales (comps) grew 1.7%, and its gross margin expanded from 33.4% to 33.7%. Lowe’s fared worse, with comps increasing just 0.2% and gross margin contracting from 33.8% to 33%.
With the economic headwinds, both companies’ stock prices haven’t fared well lately. Home Depot’s share price has lost 14.8% this year, through Sept. 25. During this time, Lowe’s stock has dropped 21.5%. They trailed the S&P 500 index’s 13.1% gain.
However, for patient investors willing to wait for economic conditions to improve and homeowners to undertake major renovations, the stocks offer upside since they trade at better valuations.
Home Depot’s stock has a P/E ratio of 21, down from 24 at the start of the year and lower than its 10-year median of 23. Lowe’s shares have a P/E multiple of 16, down from 21, which is also its 10-year median.
While both stocks trade at attractive valuations compared to their historical P/E ratios, I favor Home Depot as the better value stock compared to Lowe’s. With its bigger size giving it advantages like convenience and economies of scale, it seems Home Depot will emerge stronger once better economic times arrive.
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Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.
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