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Better Buy: Home Depot vs. Target

By John Ballard – Dec 16, 2018 at 5:18PM

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Which looks better? The leading home improvement retailer or the discount retail underdog?

Over the past year, it's become clear that several top retailers can grow just fine along with An increase in spending on home renovations has been a boon for Home Depot (HD -0.62%), for example. Meanwhile, Target (TGT 2.02%) has picked up the pace lately with improved traffic trends and booming growth in its online business, but it still has work to do to catch up to rivals in the industry.

Let's see which stock is the better bet to fuel your investment returns.

A green leafy plant growing out of a pile of coins with a city skyline in the background.

Image source: Getty Images.

Home remodeling is on trend

Home Depot stock has delivered solid gains of 130% for shareholders over the last five years. The company has steadily grown its revenue and earnings, which has supported a growing dividend. Even after the market-beating rise in the share price, Home Depot stock still offers an above-average dividend yield of 2.44%. 

A tight housing market has continued to benefit the home improvement chain. More homeowners have been willing to stay put and remodel their home instead of selling, which has led to more spending at Home Depot. In the third quarter, sales grew 5.1% driven by comp sales growth of 4.8%. A lower tax rate as a result of the Tax Cuts and Jobs Act, combined with share repurchases, boosted earnings per share by 36% year over year.

There's nothing like a strong economy to make people feel comfortable spending money to fix up their home. Of course, a recession could cause a rough patch, but Home Depot has been a great investment over the last few decades through boom and bust cycles. What's more, management continues to focus on improving operations and investing in digital capabilities to drive long-term growth.  

While the housing market remains tight, analysts believe the renovation trend will continue into 2019, and they expect Home Depot to grow earnings 14% per year over the next five years. 

Target is improving

On the other side of this faceoff, Target's share price is up just 14% over the past five years, which significantly trails the broader market. While Home Depot has managed to insulate itself from the challenge posed by e-commerce rivals, Target has been dealing with a dual threat from Amazon and Walmart. Target has mainly relied on improving store traffic to drive top-line growth while limiting store openings. As a result, revenue is up only 4.5% over the last five years. 

The company is on pace to grow comps about 5% this year, while non-GAAP earnings per share should grow about 14% over 2017. Operating costs have climbed this year as management makes investments in e-commerce and other initiatives to grow sales. These investments have pressured margins, but the company has managed to deliver growth in earnings by paying a lower tax rate. 

Like many retailers, Target has seen robust growth lately from e-commerce, with online sales soaring 49% in the third quarter. Management continues to spend heavily to enhance online order fulfillment, as well as in other areas to grow the company -- remodeling stores, expanding assortment, changing merchandise presentation, and boosting customer service, for example. 

Analysts expect Target to grow earnings 8% per year over the next five years. 

Which is the better buy?

Between the two companies, Home Depot appears to be in a stronger competitive position in its respective market than Target is at the moment.

While Target's recent performance has improved, the company still lags Walmart in e-commerce. Walmart generated $11.5 billion in revenue from e-commerce last year, while Target generated just $3.9 billion. In recent quarters, Walmart has been growing e-commerce sales just as fast as Target, which should keep the Bentonville, Arkansas, retailer firmly in the lead over its smaller peer. 

Also, 56% of Walmart's sales units are groceries, while Target generates only 20% of its sales from food and beverage. Groceries have proven to be a major advantage for Walmart since customers will likely continue visiting Walmart stores during a recession to buy essential food items. Target relies more on economic-sensitive categories like apparel and home furnishings, which puts the company at a disadvantage.

This table has some key metrics for our two competitors.

Metric Home Depot Target
Forward P/E 17.52 12.65
Dividend yield 2.44% 3.80%
Revenue growth (TTM) 4.65% 3.68%
EPS growth (TTM) 25.8% 12.8%

Data source: Yahoo! Finance and YCharts. TTM = trailing 12 months.

Home Depot has delivered faster growth on both the top and bottom lines in recent years. Brand Finance ranks Home Depot as the 27th most valuable brand in the world, which is miles ahead of Lowe's ranking at No. 106. Home Depot dominates the home improvement market, whereas Target is playing catch-up to cutthroat competitors like Walmart and Amazon.

Home Depot is not the cheaper stock, but I think investors will be better off over the long term going with the world's largest home improvement retailer.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. John Ballard has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has the following options: short February 2019 $185 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.

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