Wall Street is nervous about a potential recession on the way, and that means there are deals to be had in several parts of the stock market. Discounts are especially tempting in the home improvement industry, which is likely to see a period of depressed earnings results ahead. Both Home Depot (HD 0.94%) and Lowe's (LOW -0.04%) stocks trade in negative territory so far this year compared to a 10% increase in the S&P 500. Those declines boosted yields for these two dividend payers as well.
It might not make sense for most investors to purchase both companies at the risk of becoming too exposed to a single retailing niche. So, let's take a closer look at these discounted stocks to see which one is the better fit for your portfolio.
Home Depot is a leader
Home Depot will appeal to investors who don't mind paying up to own a high-performing industry leader. The retailer routinely beats Lowe's on growth, for example by expanding sales by 3% last year compared to Lowe's 1% decline.
Part of that gap can be explained by Home Depot's larger overall market share, along with its greater penetration in the professional contractor niche. Lowe's, in contrast, gets more of its business from do-it-yourself customers who have become much more cautious in their spending commitments.
Home Depot also comes out ahead on key financial metrics like profitability, cash flow, and return on invested capital (ROIC). Its operating profit margin is several percentage points above Lowe's and ROIC, a great indicator of efficiency, is near 40% compared to Lowe's 30% rate.
Lowe's has potential, But Home Depot is still the top stock
You have to pay a premium for that performance, though. Lowe's stock is available today at 1.3 times annual sales while Home Depot is priced at closer to 2 times revenue. Lowe's is also the cheaper stock when it comes to earnings. The P/E ratio is 18 compared to Home Depot's 20 ratio.
And you still get exposure to a great business at that price. Lowe's has steadily grown its revenue base over the past decade, winning market share in the fragmented home improvement market. It has a good shot at approaching Home Depot's leading 15% profit margin as well, having recently cracked into the double digits.
And don't forget that Lowe's is the more reliable dividend payer. It maintained its annual dividend hikes through the Great Recession while Home Depot paused its increases. As a result, Lowe's streak of 49 consecutive annual increases puts it right on the cusp of joining the exclusive club of Dividend Kings.
Income investors might still prefer the industry leader given that it has a more generous dividend policy. Home Depot aims to return 55% of annual earnings to shareholders, which partly explains why its yield is higher than Lowe's today. Lowe's targets a more conservative 35% annual return through dividend payments.
In my view, Home Depot remains the more attractive stock thanks to the retailer's strong finances and leading financial metrics. These factors outweigh the higher valuation placed on this stock. Yet both companies are likely to emerge from a recession without enduring impairments to their growth or earnings profiles. And that fact makes their 2023 discounts compelling for patient investors.
