Home-improvement stores have proven resilient against fierce e-commerce foes. Home Depot (NYSE:HD) and Sherwin-Williams (NYSE:SHW) have a wide footprint of stores that put these leading home-improvement brands close in proximity to an equally wide swath of customers. Over the last decade, shares of both companies have soared over 700%, outperforming the S&P 500's return of 217%. 

An investment in Home Depot or Sherwin-Williams is a bet on growing housing activity over time. For many decades, the number of U.S. households has steadily grown, from 80 million in 1980 to 127 million in 2018. The homeownership rate hit 69% at the peak of the housing bubble in 2005 but steadily declined to 63% through 2016. That slide didn't prevent Home Depot and Sherwin-Williams from delivering monster returns. With the homeownership rate beginning to rebound, both companies have an additional catalyst to boost their operating performance, which could keep the shares marching higher over the next decade.

A woman painting a wall with blue paint.

IMAGE SOURCE: GETTY IMAGES.

Home Depot is the world's largest home-improvement retailer, and it's one of the top 30 most valuable brands in the world, according to Brand Finance. Sherwin-Williams is one of the top brands in architectural coatings and paints and has recently begun to expand its presence in the industrial market to drive long-term growth.

We'll compare the two companies on financial fortitude, valuation, and competitive advantage to determine which home-improvement brand is the better buy for investors today.

Financial fortitude

Many investors want to hear about the exciting stuff like growth opportunities and near-term catalysts that could send a stock higher. But knowing how well a company can withstand the inevitable downturns in the economy is just as important. For this, we want to look at each company's cash and debt levels. If they have debt, we want to make sure each company is generating enough profit to handle it.

Here's how Home Depot and Sherwin-Williams compare on key financial metrics: 

Metric Home Depot Sherwin-Williams
Cash $1.764 billion $182 million
Debt $25.78 billion $9.672 billion
Revenue (TTM) $105.59 billion $17.45 billion
Free cash flow (TTM) $10.07 billion $1.811 billion
Times interest earned 16.16 5.128

Data source: Y-Charts. TTM = Trailing 12 month.

Both Home Depot and Sherwin have more debt than cash on the balance sheet. Also, notice that Home Depot generates about five times as much revenue as Sherwin-Williams. That explains why Home Depot generates more free cash flow and can carry more debt.

The one metric that tilts the advantage to Home Depot is the one called "times interest earned." Times interest earned measures how many times a company can pay interest expense out of its annual operating income.

Home Depot generates enough earnings before interest and taxes to cover its interest expense 16 times over. That is much better than Sherwin-Williams, which only covers interest expense about five times over.

Winner: Home Depot.

Valuation and dividends

Here's how both companies stack up on a range of popular valuation metrics: 

Metric Home Depot  Sherwin-Williams
Trailing P/E ratio 19.34 19.59
Forward P/E ratio 17.22 18.21
PEG (price-to-earnings-growth) ratio 1.30 1.27
Price-to-free cash flow ratio 20.29 20.66
Dividend yield 2.32% 0.88%
Payout ratio as a percentage of free cash flow 45.53% 17.81%

Data source: Y-Charts and Yahoo! Finance.  

Notice how close these companies are on the price-to-earnings ratio, as well as the PEG (price-to-earnings-growth) ratio and price-to-free cash flow. Going back to what I mentioned at the beginning, both companies are benefiting from the same trends of growing homeownership over time. Investors know this, so these companies typically trade at about the same valuation.

Home Depot pays a higher yield of 2.33%, but that higher yield is a result of Home Depot's higher payout as a percentage of free cash flow. Overall, I think both companies are even, here. Sure, I could split hairs and call Home Depot the winner because it does trade for a slightly lower P/E ratio. But notice that Sherwin-Williams trades for a slightly lower PEG ratio, which adjusts the P/E ratio for expected growth based on the consensus analyst estimate.

Winner: Tie.

Competitive moat

Both Home Depot and Sherwin-Williams have benefited from positive homeownership trends in the past, and those trends should continue well into the future to drive returns for shareholders in both stocks. 

Residential activity has not reached pre-2008 levels, and existing home sales have been slow lately. These factors have created a tight housing supply situation that has caused home prices to increase in recent years. Instead of selling their homes, homeowners have been content to use their higher home equity to remodel their existing homes. This trend plays into the hands of Home Depot and Sherwin.

Home Depot has an extensive distribution network and supplier relationships that underpin a large footprint of 2,286 stores across the U.S., Puerto Rico, U.S. Virgin Islands, Guam, Canada, and Mexico. These advantages have delivered solid operating performance, with revenue and free cash flow up 34% and 61%, respectively, over the last five years. 

On the other side, Sherwin-Williams is one of the leading brands for architectural coatings and paints for professional, consumer, and industrial applications. The company has a reputation for supplying high-quality paint for do-it-yourselfers and contractors. It operates a broad footprint of more than 5,100 company-owned stores and facilities across the U.S., Canada, Australia, Europe, Asia, and South America. Over the last five years, Sherwin delivered growth in revenue and free cash flow of 68% and 95%, respectively. 

Sherwin's management has made smart uses of acquisitions to expand the brand's store footprint into new markets, putting a specialty store within a convenient distance of many contractors who rely on high-quality paints for remodeling work. Additionally, Sherwin's 2017 acquisition of Valspar significantly expands the company's reach into several industrial markets, including solutions for original equipment manufacturers, as well as food and beverage packaging. 

Both Home Depot and Sherwin-Williams are leaders in their respective markets, and I see both companies equally positioned to benefit from the same trends in growing housing activity and home renovations over time.

Winner: Tie.

Home Depot is the better buy

It's close, but Home Depot barely edges out Sherwin-Williams on financial fortitude, which is the deciding factor. Both companies are even on valuation and competitive positioning, but the world's largest home-improvement retailer gets the nod given it can more comfortably handle its debt burden than Sherwin can.

John Ballard has no position in any of the stocks mentioned. 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 Sherwin-Williams. The Motley Fool has a disclosure policy.