Despite falling 23% in 2022, home improvement retailer Lowe's Companies (LOW +4.62%) has seen its stock climb 448% over the past decade, an outstanding return that doesn't include the company's generous dividends. That performance handily crushes the S&P 500's return during the same time.
As of this writing, Lowe's shares are trading hands at $205, but some optimistic investors might be wishing for it to hit $300 by the end of 2023, equal to an impressive 46% gain. Let's see if that's even a possible scenario.
NYSE: LOW
Key Data Points
Investors should temper expectations
Right now, Lowe's stock carries a price-to-earnings (P/E) ratio of 20, which is below its trailing-five-year valuation. Assuming this P/E multiple stays constant throughout the year -- an unlikely situation that's also hard to predict -- then earnings per share (EPS) must jump a whopping 46% in fiscal 2023 for the stock to hit the $300 mark.
Has Lowe's ever seen its EPS soar that much in one year? From fiscal 2019 through 2021, diluted EPS increased at a 63% annual rate. That's a remarkable trend, driven mainly by sizable margin expansion. For fiscal 2022, which ends Jan. 27, 2023, Lowe's management team sees sales up by just over 1% (at the midpoint). And for fiscal 2023, Wall Street estimates a 5.3% sales decline.
With muted, or even negative, sales growth on the horizon, it's evident that barring a substantial expansion of margins, Lowe's will disappoint investors hoping for a 46% gain in 2023. And even a significant rise in profitability isn't in the cards. The operating margin is forecast to be 13% for the current fiscal year and 13.4% for 2023, leveling off somewhat from the rapid expansion shareholders saw in recent years. Commodity and product inflation, as well as higher freight costs, will continue pressuring margins in the near term.
Adding to the pessimistic outlook is the fact that as of this writing, Lowe's P/E ratio is higher than that of its bigger rival Home Depot, which over the past three years has generally traded at a higher valuation than Lowe's. Home Depot has also historically posted better growth and higher profitability.
Therefore, there's no reason that I can think of as to why Lowe's should be selling at a more expensive valuation multiple than its competitor, giving me reason to believe that its P/E might actually contract this year.
Challenging operating environment
Making matters more difficult for Lowe's has been the Federal Reserve's policy moves, pushing up interest rates to curb soaring inflation. Consequently, the housing market has cooled off, with the 30-year fixed rate mortgage at a more than 14-year high of 6.15%, making it more expensive for prospective buyers to enter the market.
As existing homeowners see their home values stop climbing at a rapid pace, they could be less inclined to take on expensive renovation projects, which leads to lower demand for Lowe's.
Furthermore, the business is facing tough financial comparisons thanks to revenue and same-store sales jumping above historical trends in fiscal 2021 and 2022. So it will be hard to post stellar gains on top of those figures. I think it's best for investors to temper their expectations this year.
Even if the housing market were on fire right now, Lowe's probably wouldn't be able to increase EPS by 46% in a single year. It's not some fast-growing software company. It's a massive home improvement retailer that likely doesn't have too much room left to take advantage of its scale and operating leverage in order to boost the bottom line. Plus, I don't see Lowe's profitability exceeding Home Depot's anytime soon, if ever.
As a result, a $300 price target for 2023 seems like a pipe dream. And investors should instead look at the stock with a longer-term mental framework. If you believe Lowe's can be a solid addition to your portfolio over the next five years, then it might deserve a closer look right now despite what happens with the stock price this year.
