The top two market participants, Home Depot (HD -0.04%) and Lowe's (LOW -0.42%) dominate the home improvement retail sector. Although they're competitors, they do have key differences that are important to understand.
Turning to the equity performances, Home Depot has outperformed Lowe's stock. Over the last three years through Sept. 29, the former gained 46.2% compared to the latter's 33%. Both have underperformed the S&P 500's 83%, however.
Which one is poised to deliver better returns to investors? I think Home Depot will outperform Lowe's over the long haul. Here's why I believe so.
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Larger presence
Home Depot has a much larger store count and produces higher annual sales than Lowe's. This size means it can provide attractive prices and convenience to professional and do-it-yourself customers.
Home Depot had 2,347 stores at the end of fiscal 2024 (Feb. 2), which produced $159.5 billion in sales. That's much higher than Lowe's 1,748 stores that generated $83.7 billion in sales.
Of course, while Home Depot's larger size and market share convey certain advantages, it wouldn't mean much if the company produced sluggish sales growth. However, customers still visit Home Depot's stores and website.
Despite consumers cutting back on major home improvement projects, the company's second-quarter same-store sales (comps) increased 1.4% after excluding foreign-currency translation effects. Lowe's quarterly comps increased a respectable 1.1%.
Still, Home Depot's greater presence puts the company in a better position to benefit. And it's also appealing to a wider customer base.
Expanding customer base
Home Depot has also made major investments to expand its customer base to professional contractors. This head start gives it a leg up on Lowe's. Its effort to grow its reach to professionals includes a dedicated sales force and a loyalty program.
Its push includes last year's acquisition of SRS, which distributes roofing products, landscape supplies, and swimming pool supplies. Its products cater to the professional roofer, landscaper, and pool contractor. Additionally, earlier this year, Home Depot agreed to acquire GMS, a distributor of specialty building products like drywall, ceilings, and steel framing.
These efforts will likely boost long-term sales growth. Contractors will likely buy more materials in bulk, albeit at a lower price. While that may result in a lower gross margin than individual customers, Home Depot's 33.4% second-quarter gross margin is just 0.4 percentage points lower than Lowe's 33.8%.
Expecting a higher return on capital
Home Depot's management has a well-defined and shareholder-friendly capital allocation policy. Its three priorities, from highest to lowest, are investing in the business, repurchasing shares, and paying dividends.
This has generated high returns for shareholders, even if they have dropped over the last few years. Home Depot produced a return on invested capital (ROIC) of 27.2% for the 12 months through the second quarter. Lowe's management actually produced a higher ROIC, 29.5%.
However, the home improvement sector has been under pressure for a couple of years. In 2022, before Home Depot's profits dropped, it generated an ROIC of 44.6% compared to Lowe's 30.4%. When people take on major renovation projects, out of necessity or desire, Home Depot's sales and profit growth will undoubtedly accelerate, and ROIC will rebound.
The market certainly has higher growth expectations for Home Depot, based on the stock's price-to-earnings (P/E) ratio. Home Depot has a P/E multiple of 27 versus Lowe's 20 P/E ratio (at the time of this writing).
However, given that it appears Home Depot is in a better position to benefit over the long term, the higher valuation looks warranted to me.
