Lowe's Companies (LOW -0.04%) has absolutely crushed it for investors as shares have climbed 135% in the last five years. That gain far exceeds the 83% rise of the S&P 500. And even with the major indices hitting all-time highs, Lowe's remains 8% below its peak price from December 2021.
So the business might be on your watch list as a potential opportunity. In fact, this home improvement retail stock might be considered a screaming buy right now. But that's only if you believe it can significantly increase sales to a key customer segment in the years ahead: professionals.
Changing customer composition
Behind Home Depot, Lowe's is the second-largest player in the massive home improvement industry. The business sells a broad range of merchandise, from appliances and lumber to kitchen and garden products, to both do-it-yourselfers (DYI) and professional customers. The former group handles what are typically smaller and less complex projects on their own. DIY shoppers represent about 75% of Lowe's revenue.
But the professional customer group brings in 25% of total sales, and could drive improving financial results for this business over the long term. Three years ago, pros accounted for 20% to 25% of revenue, so that figure is likely to increase over time. But Lowe's is far away from the 50/50 split that its bigger rival Home Depot has when it comes to DIYers and pros.
Lowe's CEO, Marvin Ellison, has been focused on driving greater revenue from professionals since he took the lead job in July 2018. Key initiatives include a pro loyalty program and various benefits like tool rentals, volume discounts, and a dedicated customer service desk.
But why is it so important for Lowe's to boost its position with pros? These customers, who consist of contractors, plumbers, and electricians, spend more money and visit stores more frequently. Generating a larger percentage of revenue from them translates to better financial performance.
In the last five years, Home Depot's operating margin has averaged 14.6%, higher than the 11.2% margin Lowe's put up. And during that same time, Home Depot's average return on invested capital was also higher than Lowe's. As the business starts winning over more pro customers, these metrics should improve, as they have already been doing.
The result could be robust sales growth and expanding profitability going forward. For what it's worth, earnings per share at Lowe's have soared at a much faster clip than they have for Home Depot. A continuation of these trends is the key to market-beating investment returns.
Re-rating the stock
If you believe that over the next decade Lowe's can get closer to parity with Home Depot in terms of achieving 50% of its overall revenue from professionals, then I think it's reasonable to expect the market to rerate the stock higher. The fact that the company's financials would be improving should be enough to excite investors, leading to a better valuation multiple.
As of this writing, shares trade at a price-to-earnings (P/E) ratio of 18.4. That's lower than the trailing 10-year average. And it's a sizable discount to Home Depot's current P/E multiple of 25.2. Assuming Lowe's obtains the same valuation as Home Depot, it would add 37% upside to the equation.
This business still has a lot of work to do to catch up to its larger competitor. But investors who believe that Lowe's is on the right path should take a closer look at buying the stock today.
