Home-improvement retailer Lowe's (LOW -0.88%), and image-browsing platform Pinterest (PINS -2.86%) are two of the cheapest stocks I own. And yet I can still hear readers shouting reasons at me why they aren't cheap enough. I appreciate the complexity of this topic and I agree these two stocks aren't necessarily a value-stock investor's wildest dreams come true on the surface.
The thing is, most valuation metrics, like the price-to-earnings (P/E) ratio, look back at where a company has been. But they don't tell you where the company is going. The challenge of investing is to take both into consideration -- balancing the value proposition today in light of a company's business prospects tomorrow. I take this more holistic view, and it's why I can comfortably argue that Lowe's and Pinterest are two of the cheapest stocks I own.
Image source: Getty Images.
1. Lowe's: My Steady Eddie stock
Someone recently asked me to name a stock that I owned that was dependable. Without hesitation, I said Lowe's. In my opinion, home-improvement retail is something that will always be in demand across the country. And with over 2,200 locations, Lowe's always has a location close to customers.
Home improvement spending in 2021 was $538 billion, according to Statista. This is up from $358 billion just five years ago. And by 2025, such spending is expected to surpass $621 billion. Therefore, it seems like Lowe's business opportunity is robust and expected to grow.
Some might worry about the possibility of an economic recession. And it's true, that possibility exists. But keep in mind that the U.S. economy has gone into recession before. Lowe's business barely skipped a beat during these periods, as the following chart shows -- recessionary periods are shaded gray.
LOW Revenue (TTM) data by YCharts
Home improvement retail isn't a cyclical space -- consumer demand is steady, to Lowe's benefit. While its business might not be flashy, its shareholder returns are. In 2021, Lowe's repurchased over $13 billion in stock and paid out roughly $2 billion in dividends. And speaking of the dividend, it's been paid out every quarter for nearly 60 years and has plenty of room for future increases.
The stock market is a turbulent place. That's why having a position in a company with constant consumer demand and consistent financial results like Lowe's can make a good addition to a diversified portfolio.
2. Pinterest: The stock the market gave up on
In contrast with Lowe's, I wouldn't necessarily call Pinterest a sure thing. The company has been struggling to grow its user base and keep them active on the platform. As of Feb. 1, there were almost 437 million monthly active users worldwide, down from 478 million in March 2021. This nearly 9% decline is why Pinterest's stock price is down 75% from its all-time high -- the market's given up on it.
Keep in mind that unlike many tech stocks, Pinterest actually earns real net income (profit) and its valuation can, therefore, be measured by its earnings. Pinterest stock has a P/E ratio of 48 -- way more than Lowe's P/E of 17. And it trades at just 21 times next year's earnings estimates. These valuation multiples may seem generous, but they're the cheapest it's ever traded at and not outrageous given Pinterest's earnings growth to date and potential.
Of course, if Pinterest can't keep growing its earnings, then this will be what's called a "value trap" -- a stock that looked cheap but didn't generate shareholder value. And to be sure, with its currently slumping user base, it'll be challenging to grow earnings.
That said, Pinterest is an exemplary company when it comes to investing in its business the right way. Look at its operating expenses. In the fourth quarter of 2021, two expenses that you'd like to see come down did. General and administrative expenses (corporate overhead) were down to 11% of revenue compared to 12% in the previous year. And the cost of revenue decreased from 18% of revenue to 17%, as the company's gross margin continues to improve.
Seeing these two expenses come down is encouraging. Likewise, if a company is going to spend money to grow, you'd like to see spending in sales and marketing (S&M) and research and development (R&D). And that's what Pinterest is doing. Q4 S&M expenses increased from 17% of revenue to 23% as management invested heavily in a brand marketing campaign that could make the platform more attractive to advertisers. And R&D expenses jumped from 23% of revenue to 28% largely due to new hires in that department.
Developments in Pinterest's technology and capabilities could reinvigorate user engagement and stimulate spending from advertisers -- the kind of things that could lead to outsized earnings growth for Pinterest. While this outcome is far from certain, considering Pinterest's cheap valuation, now may be a great time to invest in its stock.
It's not just about being cheap
The trick to buying good stocks isn't simply finding what's cheap. Otherwise, anyone with a good search tool could filter out expensive stocks and be an investing guru. Rather, investing is about finding companies where the business results can produce shareholder returns in excess of what the market average can provide -- an analytical step beyond just reading the cold numbers on a page.
Sometimes these shareholder returns come from steady companies like Lowe's that are returning capital to shareholders at an impressive rate. Other times they come from companies like Pinterest that are just starting to stretch their financial wings and optimize their operations for profits.
Buying cheap stocks does reduce valuation risk -- that's good. But the burden is still on companies to execute. So whether you're buying Lowe's, Pinterest, or something else, be sure you're investing in the "horse": the business fundamentals. The stock valuation is the so-called "cart" and should play a complementary role in investing decisions.
