The BMW Method
Home Depot and Lowe's a Bargain?

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By kelbon
November 21, 2007

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How good a buy are Home Depot and Lowe's at these prices?

Historically speaking they certainly seem to be in the bargain bin. But if we take a closer look something slightly different might emerge. Lowe's forward looking earnings have now been reduced to $1.83 to $1.87 a share. At $22.51 that gives LOW a forward looking p/e of just over 12. This price supposes an earnings growth increase that is modest at best. So far Lowe's still looks like a bargain but doesn't put it in the bargain basement yet.

However, if we take into consideration that indeed we have seen an unprecedented run-up in house prices over the last few years; when a lot of people were feverishly doing house improvements with a quick flip in mind, then perhaps Home Depot's and Lowe's previous earnings weren't typical of a more normalized climate and the chances that they will ever revisit former levels is unlikely - certainly in the foreseeable future.

Another engine of growth for both HD and LOW was the continual opening of new stores, year in and year out. Clearly at some point there has to be a saturation point. Now, there aren't many people who are not within striking distance of either at this point - so there has to be diminishing returns in continuing to open new stores; at least in the U.S. I'll give Lowe's the advantage here because they have about three domestic stores to Home Depot's four - therefore having slightly more potential for growth and generating more income even at the expense of diminishing same-store sales.

However, Home Depot's ROE has been greater than Lowe's, seemingly giving them an advantage, but non-the-less HD has managed to shoot themselves in the foot along the way with bad customer service, borrowing money to buy back shares at much higher prices than today's, etc. Lowe's certainly has the advantage as far as the ambiance of their stores and customer service goes. Sometimes perception is everything and HD has an uphill slog to change it.

Perhaps what is going to put a floor under both stocks is the fact that they both own most of their stores and the land that they sit on. The hidden value of both is real estate. When you see someone smart figuring out what that value is and factoring it in with the other assets - perhaps Eddy Lampert, for instance, and then making a major bet - that could be the 'buy' signal.