Home-improvement retailers such as Home Depot (NYSE: HD) and Lowe's (NYSE: LOW) are sitting just below their respective 52-week highs, but I think that there still might be a lot left in the tank for these companies. There are a few big factors that should prove to be very positive catalysts for the profits of both companies over the next several years. These include the housing market, which has more upside potential than people seem to think, and the next generation of a lot of home products, which should trigger a replacement cycle.
The housing market had a great 2013 in general, with the average home price up about 12.5% from 2012, and many people think 2014 will be a much less exciting year for real estate. Personally, I think the housing growth is just getting started. And unlike the early to-mid 2000s, this will be real, sustainable housing growth, not just speculation.
Homebuying in the U.S. is at historically low levels, even after the recent gains, which is remarkable considering how affordable it is to buy a house right now with mortgage rates of less than 5% (higher than a year ago but still very low in a historical context). It's not so much that more people are choosing to be renters but that more adults ages 18 to 31 are still living with their parents or in roommate situations than any other time in recent history.
In fact, according to the Pew Research Institute, 36% of adults in this age group (aka the millennial generation) still live at home, and this trend has been rising since the start of the recession in 2007. It is especially surprising that the number of younger adults who live at home is even higher than at the end of the recession, 2009, which is considered by most to be the worst year in recent history in terms of employment opportunities.
I believe that homeownership will come back into favor as soon as the general confidence about the U.S. economy begins to significantly improve. The incredibly easy passage of a budget this week and the recently announced Fed taper are very good signs of true economic progress, and should go a long way toward raising confidence in our economy, which is essential to convince people that they should invest in a home of their own.
There are several types of products that are just now becoming accepted on a wide scale that could create lots of additional revenue for home-improvement retailers. Most of what I'm referring to here has to do with "smart-home" technologies. Home Depot's CEO recently mentioned Wi-Fi-enabled locks as a game-changing product, but there are many other such products that could be the next "must-haves" for homeowners.
How many more people do you know that have "high-efficiency" lightbulbs in their home as compared to just a few years ago? The same thing could happen with some of these new, more expensive items. Home Depot now carries a full line of technologically advanced "smart-home" products that help manage energy usage and provide home-automation solutions designed to bring houses into the modern age.
At 21.3 times the current fiscal year's expected earnings, Home Depot may seem a bit expensive at first glance. However, take into account that earnings are projected to grow to $4.43 and $5.11 during the next two fiscal years, which translates to an average annual earnings growth rate of 16.7% -- which more than justifies the current valuation multiple.
Lowe's is in a similar situation but with a slightly higher current valuation and higher future growth expectations. At 22.1 times this year's earnings and 21% annual earnings growth expected, Lowe's looks downright cheap at the moment.
Even though on paper Lowe's looks like the better option right now, I'm not necessarily advocating for one company over the other. I simply think that both will benefit greatly over the next few years, and there really is no "wrong" choice between the two.
Fool contributor Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.