The housing market continues to improve, as evidenced by a variety of positive housing-related data points. This can only mean good things to come for the major U.S. home improvement retailers, Home Depot (HD -0.07%) and Lowe's Companies (LOW -0.07%).
The broader economy continues to sputter along, evidenced by weak growth in gross domestic product, and the labor market is still showing tepid improvement at best.
However, the housing market has proven to be a pillar of strength in an otherwise frustratingly slow recovery from the depths of the Great Recession.
Improving fundamentals, strong brands, and continued strength in the housing market are why Home Depot and Lowe's are succeeding in this challenging environment, and will continue to do so going forward.
Improving investors' portfolios, one brick at a time
Reuters reported that existing home sales in the United States surged in July to their highest level since November 2009. In all, existing home sales climbed 6.5%, and housing analysts and economists alike see a solid foundation set for a continued housing recovery.
Not surprisingly, both Home Depot and Lowe's are reaping the rewards.
Home Depot reported first-quarter sales growth of 7.4% year over year. Same-store sales growth for the first quarter clocked in at a healthy 4.3%, with U.S. same-store sales growth coming in at a robust 4.8% during the quarter.
The momentum continued in the second quarter, in which Home Depot racked up solid 10.7% growth in same-store sales. Diluted earnings per share, meanwhile, soared 23% year over year.
Lowe's hasn't had as smooth of a year as its major rival, but the company has performed better recently.
Lowe's widely disappointed when it reported mediocre first-quarter results. Sales fell 0.5% from the same period one year ago. Furthermore, while the company's first-quarter earnings per share rose 14% year over year, the results missed analyst expectations.
Thankfully, things improved substantially in the company's most recent quarter. Lowe's reported second-quarter same-store sales growth of nearly 10%, and impressive 37.5% growth in diluted earnings per share.
As Chief Executive Officer Robert Niblock indicated in the earnings release, Lowe's improved results stem from a concerted effort to revamp its pricing structure, focusing on everday low prices rather than temporary discounts. Moreover, the company benefited from friendlier weather conditions in the second quarter, and of course, its results were buoyed by the pronounced strength in the housing market.
Not all home improvement retailers are created equal
Unfortunately, not every retailer in the space is reaping the rewards of an improving housing market.
Sears Holdings (SHLDQ) fell 9% after releasing its own second quarter results, which widely disappointed.
Sears reported a wider-than-expected loss, of $194 million, due largely to a 1.5% drop in same-store sales. Total revenue fell 6%, mostly because of store closings.
Sears offers a wider range of products outside of home improvement, but even its housing-related segments performed poorly. For example, sales of appliances were weak, which stands in stark contrast to the success of Home Depot and Lowe's.
A promising future for the best-in-breed home improvement retailers
The improvements in the housing market, as impressive as they are, still look to be in the beginning stages. Economic data rolls in seemingly every day that signals continued strength in the housing market going forward. And, while interest rates are higher than where they were a few months ago, home affordability still remains near historically high levels.
Home prices are recovering in many cities, evidenced by findings from the National Association of Realtors stating home prices rose in 87% of U.S. cities in the second quarter, but still remain well below pre-recession levels.
Furthermore, the gradually improving unemployment rate means more money in consumers' pockets for home repairs and renovations, meaning business conditions for Home Depot and Lowe's should remain firm this year.
As a result, the two major home improvement chains, Home Depot and Lowe's, both look like good bets based on their valuable brands and history of strong execution.
It's true that both stocks are far from being bargains. After all, both Home Depot and Lowe's trade for at least 24 times trailing earnings and 20 times forward earnings. These are healthy premiums to the broader market. The S&P 500 trades for a P/E multiple in the high teens.
In addition, neither Home Depot nor Lowe's pays a market-beating dividend. Each stock yields between 1.5% to 2%, which is less than the 2.2% the broader market pays.
However, neither stock should be considered an income play. These are growth stories, and on that front, there's little for investors to worry about.
Bottom line: Stick with Home Depot and Lowe's
While Sears continues to struggle, it becomes apparent that not all home improvement retailers are capitalizing on the improving housing market. As a result, it's imperative for investors to focus their attention on the clear winners in the space.
Both Home Depot and Lowe's are growing strongly, a trend that should continue due to the accelerating momentum of the housing market and broader economy. Therefore, investors shouldn't worry about their valuations, and continue to hold both stocks with confidence.