Home improvement sales have been one of the surprising side effects of the coronavirus pandemic. Folks who planned on spending a lot more time at home thought they might as well make their living spaces as comfortable as possible.
Home Depot (HD -1.44%) and Lowe's (LOW -0.88%) have benefited from the trend tremendously. Still, Home Depot stock sells at a premium price compared to Lowe's when measured by the price-to-earnings and price-to-free-cash-flow ratios. Let's look closer to determine whether that premium price is justified.
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Home Depot beats Lowe's on vital growth metrics
Interestingly, over the past decade, Home Depot has grown revenue at a compound annual rate of 7.9% vs. a rate of 6.7% for rival Lowe's. So looking specifically at long-run revenue growth rates, Home Depot has the advantage.
The home improvement industry was worth an estimated $900 billion in 2021. Home Depot and Lowe's combined for roughly $248 billion of that total in 2021. So, despite their massive sizes, there is room for both retailers to keep growing.
LOW Revenue (Annual) data by YCharts.
Looking at the inventory turnover ratio, Home Depot has consistently held the advantage over Lowe's. This measures how quickly a company sells its inventory and is an essential metric for brick-and-mortar retailers. The most recent turnover ratio for Home Depot was 7.8 vs. 5.7 for Lowe's.
The faster you can sell a product, the sooner you can put a new product on the shelf, boosting revenue over the quarter and year. The metric also demonstrates merchandising prowess. To move products faster than your competitors means you understand what your customers want better, showcase the product better, and have earned the trust of the home improvement customer.
LOW Inventory Turnover (Annual) data by YCharts.
And finally, Home Depot has long delivered a superior operating profit margin to that of Lowe's. Sometimes, companies sacrifice profit margins to make more sales. It's no secret that lower prices induce consumers to buy more. That Home Depot has generated better revenue growth and superior profit margins highlights the strength of Home Depot's execution.
Home Depot's premium valuation is justified
Earlier, I mentioned that Home Depot stock was selling at a premium to Lowe's. More specifically, it is trading at price-to-earnings and price-to-free-cash-flow ratios of 27.5 and 18.9, respectively. On those same metrics, Lowe's sells at 19.2 and 15.7, respectively.
LOW price to free cash flow data by YCharts. PE ratio = price-to-earnings ratio.
Yet, it is also true that Home Depot has better revenue growth, higher margins, and quicker inventory turnover. So to answer the question posed in the headline: yes, Home Depot does deserve its premium valuation.
