Investors have become more cautious about home improvement stocks lately. Rising interest rates and the threat of a recession on the way sparked fears about weak growth ahead for the industry following many years of fantastic gains.
Yet these concerns are short term in nature. Meanwhile, declining stock prices have lifted dividend yields for both Home Depot (HD -1.77%) and Lowe's (LOW -1.40%) stocks, which have thrived through many past recessions. But which stock is the better dividend investment today? Let's take a closer look.
The market share challenge
Lowe's struggled to close the market share gap with its larger rival in 2022. While Home Depot achieved a 3% comparable-store sales increase, Lowe's result was flat for the year. Both companies saw rising spending, in part thanks to higher prices. But customer traffic declined less at Home Depot (down 5%) than it did at Lowe's (down 7%) this past year.
Home Depot benefited from its better market share position, and from the fact that it caters more to professional contractors. Lowe's more focused sales footprint, leaning more toward do-it-yourself-ers (or DIY-ers), leaves it exposed to swings in consumer spending habits. That's why Home Depot stock has the edge when it comes to its growth potential.
Profits and cash flow
Home Depot is also more profitable, but the gap here is shrinking. Lowe's boosted operating margin in 2022 and is projecting another uptick this year, to between 13.6% of sales and 13.8% of sales. Home Depot has consistently outpaced its smaller rival on this score, but the 14.5% rate management is expecting in 2023 is only slightly better.
LOW Operating Margin (TTM) data by YCharts.
Cash flow is a key concern for income investors, since this metric correlates to long-term dividend growth. Both retailers endured declines here in 2022 after soaring results in the prior year. But Home Depot remains the industry leader. Annual operating cash flow dipped to $14.6 billion last year from $16.5 billion. Lowe's comparable figure landed at $8.6 billion compared to $10.1 billion in 2021.
Valuation and outlook
Home Depot has a slightly brighter growth outlook for 2023, as management is calling for sales to be flat compared to Lowe's forecast of a 1% decline. The industry leader's dividend, which was boosted by 10% this past year, is paying a higher yield today of 2.8%.
As you might expect, the companies' respective stock valuations reflect Home Depot's stronger sales, profit, and cash return metrics. An investor has to pay 1.8 times sales for Home Depot stock today, compared to Lowe's price-to-sales ratio of 1.3 times.
The premium seems worth it in this case. Home Depot stock provides higher income and more stability, for just a slightly higher valuation. Sure, Lowe's shares might outperform Home Depot's if the retailer can continue boosting profit margin toward 15% of sales.
But most investors will prefer Home Depot for its proven ability to grow sales and profits through a wide range of selling conditions. Volatility could always push stock prices lower in the short term, but Home Depot seems like an attractive long-term buy for income investors.
