While Home Depot (NYSE:HD) works overtime to return to its retailing roots, rival Lowe's (NYSE:LOW) continues to chip away at its archrival's home improvement leadership position.

Home Depot is still a larger firm; it's recent market capitalization of just under $85 billion exceeds that of Lowe's by nearly $32 billion, but that's precisely why Lowe's has been able to grow more rapidly. As of year end, Lowe's operated 1,375 big-box stores here at home, while Home Depot operated 1,872 stores domestically, with another 228 abroad and 47 specialty stores. And Lowe's has yet to enter a number of large metropolitan areas.

In terms of what to expect going forward, we'll have to wait until next week for Home Depot to offer its 2007 outlook and business strategy that may include selling off its do-it-for-me supply business, which doesn't currently have a strong integration with the retail stores. In contrast, Lowe's reported fourth-quarter earnings that weren't as bad as forecast, and its guidance for 2007 didn't stink as bad as investors had feared. As a result, Lowe's stock hit a new 52-week high Friday and traded up as much as 5%.

So here's where we stand currently: Lowe's should be able to better withstand homebuilding industry woes than its orange rival and also grow total sales faster via growth in new stores. For 2007, management projects square footage expansion of around 11% and could maintain a double-digit pace for at least the next few years. And this is just domestic growth.

On the other hand, Home Depot is posting worse same-store sales trends and may have underinvested in keeping existing stores competitive. It also has a new CEO and must decide whether to embrace or shun Home Depot Supply. The company may increasingly look abroad for new store expansion opportunities.

Sounds like a no-brainer to me as Lowe's is the less risky bet, but as you might expect, Mr. Market has already identified the key drivers of each stock. As a result of Home Depot's woes, it trades at a lower valuation (using price-to-earnings and enterprise value-to-sales ratios) than Lowe's. That makes the playing field more level, so it's hard to say which will perform better as a stock. Exposure to both may be the best way to go; I still think Home Depot and Lowe's have solid prospects and will continue to collectively dominate the home-improvement retailing space for years to come. Only Builders FirstSource (NASDAQ:BLDR) and Building Materials Holding (NYSE:BMG) show up on a screen of publicly traded competition, and neither is likely to turn up the heat on the DIY giants.

For related Foolishness:

Home Depot is a recommendation of Motley Fool Inside Value. Discover why the home retailer has built up a market-beating performance record with a free 30-day trial.

Fool contributor Ryan Fuhrmann is long shares of Home Depot but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.