It pays to be the leader in an industry. The company with the dominant market share tends to accrue outsize profits in its niche, after all, along with faster sales growth.
That's true even during a cyclical downturn, which is what the home improvement industry is experiencing right now. Both Home Depot's (HD 0.94%) and Lowe's (LOW -0.04%) businesses are shrinking today as consumers scale back on real estate spending. But in a recent earnings report, Home Depot gave investors a few reasons to feel more optimistic about its long-term outlook. Let's look at some key factors making the industry leader's stock stand out as the better buy.
1. Stable demand trends
Both companies reported a 2% decrease in comparable-store sales for the selling period that ended in late July. Look deeper into Home Depot's demand trends, and you'll see some encouraging signs of strength.
Customer traffic declines improved to a 2% drop from a 5% slump in the prior quarter, for example. Home Depot saw more demand flow through its online selling platform and shoppers were happy to spend on smaller projects in areas like plumbing and outdoor garden supplies.
Wins here almost fully offset declines in big-ticket projects such as appliances. And average spending would have been higher by about 2% (instead of flat) if not for sharp deflation in the price of lumber. Yes, spending levels are falling in the industry. But Home Depot is handling the challenge well, as it has in all previous cyclical downturns.
2. Financial wins
Two of Home Depot's core financial metrics reflect its prime position in the industry. The first is profit margin, which last quarter sat at over 15% of sales. In mid-August, the retailer affirmed its outlook calling for operating income to land above 14% of sales for the full year. Lowe's is aiming for a margin between 13.4% and 13.6%.
LOW Operating Margin (TTM) data by YCharts
Home Depot's return on invested capital (ROIC) also towers above its smaller rival's. Both retailers' metrics have worsened in recent quarters thanks to the combination of weaker sales and rising interest rates, but Home Depot's ROIC was over 40% this past quarter while Lowe's was closer to 30%.
ROIC is an excellent metric for investors to follow as it reflects a management team's ability to efficiently allocate increasing amounts of capital. Home Depot has a proven track record on this score, including the company's use of low-interest-rate debt to help fund aggressive stock buybacks.
3. Price check
Home Depot's stock has underperformed its smaller peer in 2023, making its valuation slightly more appealing in comparison. You can own the industry giant for 2.2 times sales right now, down from its pandemic high of 3 times annual revenue. Lowe's shares are priced at 1.5 times sales, in comparison. Home Depot pays a higher dividend yield at 2.5% compared to Lowe's 2%.
Some investors will prefer Lowe's stock here simply due to that valuation discount. The company is making strides closing the performance gap with Home Depot, too, in key areas like sales growth and profitability. Further gains here could push Lowe's valuation up toward its larger peer's.
Yet Home Depot has dominated in these categories through many economic booms and busts. It will probably lead the industry out of this slump, much like it has in previous rebounds. Fundamentals like the aging housing stock and favorable demographics will support that recovery. "We are bullish on the future of this market," CFO Richard McPhail said in a recent conference call. Investors should feel just as bullish about Home Depot stock's long-term prospects.
