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Better Buy: Amazon vs. Home Depot

By Parkev Tatevosian - Feb 19, 2021 at 10:38AM

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Both companies' sales have surged during the pandemic. But which is more likely to make your portfolio surge?

Amazon (AMZN 4.03%) and Home Depot (HD 3.15%) have both benefited from increasing sales since the start of the coronavirus pandemic. The pandemic is also creating challenges for both companies -- increasing customer demand, fulfillment costs, COVID-19-related expenses -- although their business models are vastly different. Amazon's retail operations are almost entirely e-commerce oriented, while Home Depot's business is mostly focused around its brick-and-mortar presence

As for their differences, while Amazon is growing its e-commerce revenue rapidly, it can only aspire to reach the profit margins that Home Depot achieves consistently. 

So which retail giant would make a better buy for investors looking to open a position now? Let's weigh the numbers.

A chart comparing Home Depot and Amazon on financial operating metrics.

Data source: YCharts.

The case for Amazon 

Amazon is currently growing revenue at a rate that will allow it to more than double its top line every three years. That's a rate that defies the law of large numbers. Consider that as recently as 2011, Amazon's annual sales were only $48 billion. In 2020, its revenue totaled $386 billion -- eight times higher. Fueled by surging demand from consumers shunning in-person retailers, revenue increased by more than 37.6% year over year in 2020. 

Consumer Intelligence Research Partners (CIRP) estimates that there are 142 million Prime members in the U.S. Moreover, CIRP estimates that 30 million of those members joined the loyalty program in 2020. The free and faster shipping alone makes it a compelling value at a time when venturing into a store carries the risk of contracting a deadly virus. A fair percentage of these newly acquired members will certainly stick around long after the threat of COVID-19 diminishes.

And its Amazon Web Services (AWS) segment, which offers cloud computing to enterprises and institutions, is punching well above its weight in terms of profit contribution. While the segment accounted for just 12% of revenue in 2020, it provided 52% of operating profits. 

Amazon is the market leader in the cloud services category, which is forecast to grow at a compound annual rate of 17.5% through 2025. That could lead to an increase in profitability for Amazon, which for most of the past decade sustained an operating profit margin near or below 5%. 

Overall revenue growth may decelerate for Amazon in the aftermath of the pandemic. However, most of that slowing will come from less-profitable parts of the business, while AWS can be expected to continue to thrive. 

A woman making a choice.

Image source: Getty Images.

The case for Home Depot

In recent quarters, sales have been increasing at more than double the usual rate for the home-improvement retailer as a result of a confluence of well-known factors. People are spending more time at home -- working, going to school, and entertaining themselves -- and this has driven them to put more resources into improving their environments.

At least one of these factors -- the telecommuting trend -- looks likely to keep its legs even after the risk of COVID-19 is diminished. Several major companies have announced they will offer flexible arrangements where employees can choose to work from home some or all of the time. 

The recent surge in sales is being driven by do-it-yourself customers as people are reluctant to let professional contractors into their homes. This could lead to an unleashing of demand for professional services in the aftermath of the pandemic. However, even if that does manifest and provide a further tailwind to revenue growth, the effect will not be long-lasting. Once the pent-up demand is worked through, professional home repairs should return to their pre-pandemic levels. 

Over the last decade, Home Depot's revenue grew at a compound annual rate of 5.2%. Given our current societal trends, it would not be surprising if Home Depot's revenue growth rate approaches a double-digit percentage over the next 10 years. Still, that would be less than half of the 23% year-over-year revenue growth of the previous two quarters.

The verdict 

A chart comparing Home Depot and Amazon on price to earnings ratio and price to sales ratio.

Data source: YCharts.

Amazon has better prospects for growth during and after the pandemic, while Home Depot has the edge when it comes to operating efficiency. However, Amazon is increasing its margins quickly -- its operating profit margin rose from 1.8% in 2011 to 5.9% in 2020. And while both companies' revenue growth rates are likely going to decline from their recent levels, Home Depot's retreat is going to be larger.

Amazon's favorable outlook is priced into its stock. Compared to Home Depot, Amazon is trading at a premium when measured by its forward-price-to-earnings and forward-price-to-sales ratios. But those premiums are justified given Amazon's catalysts for growth and its increasing profit margins. Both companies are likely to increase the wealth of their shareholders in the long run, but Amazon will do that better than Home Depot. 

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Stocks Mentioned, Inc. Stock Quote, Inc.
$2,221.55 (4.03%) $86.05
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
$302.81 (3.15%) $9.24

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