Is Home Depot (HD) Stock a Better Bet Than Lowe’s?

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I’ve had a hard time lately with Home Depot (HD) and Lowe’s (LOW). Both are first-rate home improvement companies, and the climate for the business is currently excellent.

Is Home Depot (HD) Stock a Better Bet Than Lowe's?But I’ve always been partial to HD over LOW stock, mainly because Home Depot has beat or met consensus estimates in its last three quarters, leading HD to trade similar to a “growth at a reasonable price” stock —  showing great growth characteristics but trading below a price-to-earnings growth ratio of 1.

About three months ago, LOW stock seemed the more value-oriented play. So I sold HD stock and bought into LOW. Now, with earnings out, I have to check in and evaluate the situation.

HD Vs. Low Stock: Home Depot’s Earnings

Home Depot had some pretty awesome sales, coming in at $24.8 billion for the quarter, which was a 4.3% increase over last year. Same-store sales were up at a modest 4.2%, with 5.7% increases in the domestic stores.

Don’t be fooled by the increase in earnings, which went from $1.52 to $1.73. That was due to HD buying back shares, which lowered the denominator of that ratio. You must examine net income, and it’s there you will find a mere 9% increase from $2.05 billion to $2.23 billion.

As for the first half of Home Depot’s fiscal year 2016, HD’s revenues were $45.72 billion, up 5.1%. Net income increased to $3.81 billion from last year’s $3.43 billion, an 11% jump.

Again, looking at per-share earnings including buybacks, EPS rose from last year’s $2.53 to $2.95.

What I see is a very respectable growth trajectory of about 11%. I also see about $5 billion in cash on the balance sheet and $5.19 billion in free cash flow so far this year.

Alas, Home Depot has gotten way ahead of itself from a valuation standpoint: HD stock is pushing $123, and it trades at a multiple of 23 on this year’s projected earnings. I would certainly give Home Depot a premium for its great free-cash flow and its fantastic brand, but even then, I cannot justify a P/E greater than 14. To me, the stock is therefore overvalued by more than half.

Low Vs. HD Stock: Lowe’s Earnings

Lowe’s delivered results that were fairly similar. Revenues came in at $17.3 billion for the quarter, up 4.5%, and comps increased by 4.3%. Lowe’s saw earnings of $1.13 billion, equaling $1.20 per share of LOW, up from $1.04 billion and $1.04 per share.

And, yes, Lowe’s experimented with some buyback financial engineering on the bottom line, too.

For the first six months, sales were up an unimpressive 4.9% to $31.48 billion. On the bottom line, we see net income of $1.8 billion, up from $1.6 billion, an increase of about 8%.

Meh.

I can say that net margins improved in Q2 to 6.5%, up from Q1’s 6.3%. Still, compared to HD stock’s 9% margins, you can see who is executing better.

Lowe’s has $1.5 billion in cash and investments, and is not as hobbled with debt — $10.34 billion compared to Home Depot’s $17 billion. I also like LOW stock’s $3.8 billion in free cash flow thus far this year. Still, it’s also lower than Home Depot’s.

Lowe’s stock is trading at 22 times its projected earnings for the current year. However, like Home Depot, even with a 20% premium tacked on for brand and cash flow, that only gets us to a fair value of around 11 times earnings based on its 8% earnings growth.

I just don’t see paying twice fair value for LOW stock.

As for the differences, HD stock is clearly executing better. It has better margins, better cash flow and probably a slightly more recognizable name globally.

It’s a tough call. Frankly, I would pass on both for now since they are too expensive. If I had to own one, then I would choose HD stock. Personally, after just having evaluated these numbers, I exited my LOW stock position.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.

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