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3 Reasons Lowe's Is a Better Dividend Stock Than Home Depot Inc.

By Demitri Kalogeropoulos – Jul 8, 2017 at 9:50AM

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Don't let the lower yield convince you to write Lowe's off as a better income investment.

Buying Home Depot (HD -1.09%) stock today will give you a 2.3% yield, or just a touch higher than the 2.1% you'd get with a Lowe's (LOW -2.09%) purchase. That's not an insignificant gap.

However, there are good reasons to prefer Lowe's as an income investment over its chief home-improvement rival, even after accounting for that lower yield.

A mason jar full of coins, labeled "dividends".

Image source: Getty Images.

Longer track record

Lowe's has raised its dividend each year since it went public in 1961. For investors keeping track, that marks 46 straight years of payout boosts -- easily enough to qualify the retailer as a Dividend Aristocrat. 

In contrast, Home Depot isn't invited to that exclusive income club. The company paused its dividend for three years during the worst of the housing market crisis after sales slumped and profitability plummeted. Lowe's operations took a similar hit, but because management had been more conservative in its capital return plans it had slightly more resources available to continue that growth streak.

LOW Dividend Chart

LOW Dividend data by YCharts.

The unbroken streak has helped Lowe's dividend grow at a quicker clip over the last decade, up over 400% compared to Home Depot's roughly 300% boost.

Lower payout ratio

Lowe's aims to pay out just 35% of its annual earnings in dividends, compared to Home Depot's 55% goal. A major benefit of that conservative payout ratio, besides its built-in protection during market tumbles, is that it leaves room for growth.

There's not much short-term potential for this payout ratio rising, especially since Lowe's is busy shelling out on expanding its store base right now. It plans to add 35 new locations this year, after all. On the other hand, Home Depot's steady sales footprint likely played a big role in management's more aggressive payout target.

Lowe's is up to 2,129 home improvement stores, not far from the market leader's 2,278 warehouses. That makes it likely that at some point in the not-too-distant future, Lowe's will be close to full market coverage and can ease up on the physical expansion plans. A payout ratio that's closer to 50% of sales than 35% would be a natural consequence of that evolution.

Room for improvement

Lowe's trails Home Depot -- by a wide margin in many cases -- in several key financial and operating efficiency metrics. Its profit margin is 9% compared to Home Depot's 14%. Lowe's return on invested capital is less than half Home Depot's 30%, too. And the retailer's comparable-store sales growth consistently lags that of its bigger rival. Last quarter, for example, its comps were roughly one third of the 6% that Home Depot managed. 

To some extent, these gaps represent benefits of scale and size that Lowe's isn't likely to replicate any time soon. After all, Home Depot is set to pass $100 billion of annual sales in the next year while Lowe's revenue base hovers around $70 billion. Home Depot's management team is also unusually skilled at capital allocation, and so it would be a stretch be expect Lowe's to get its ROIC figure up to similarly stratospheric levels.

That said, the company is exposed to all of the same market trends that are lifting Home Depot's operations right now. Like its larger rival, Lowe's is well positioned to cash in from rising home prices, rebounding household formation rates, and higher retail spending on the part of professional contractors. Thus, its business has a path toward improving its profitability and comps growth figures to at least bring them closer to the rates enjoyed by the market leader over time.

Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.

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