Home Depot or Lowe's? That is the question. OK, let me clarify here. My wife and I are homeowners, and we give both places their fair share of business. However, which one is the better investment? Are you better off dropping your dollars on a few shares of Home Depot (NYSE: HD)? Or is Lowe's (NYSE: LOW) the better way to build your portfolio? By taking a look at a few common ratios over time, we can get a better idea of which company may be the better bet.

Return on equity
Warren Buffett likes looking at a company's return on equity because it is a key indicator of not only how profitable the business is, but also how well the company's assets and leverage are being managed. Think about it this way: A company earning $1 million in a given year on $5 million in shareholder equity is doing a better job than another company earning $1 million on $20 million in shareholder equity. This is what return on equity tells us. So how do Home Depot and Lowe's measure up here? Let's take a look:

 

TTM

2010

2009

2008

2007

5-Year Avg.

Home Depot

15.1%

14.1%

13%

19.7%

20.3%

16.4%

Lowe's

9.7%

9.6%

12.9%

17.7%

20.7%

14.1%

Source: Capital IQ, a division of Standard & Poor's.

Based on the five-year averages here, Home Depot looks a little sturdier.

Operating margin
When we talk about margins, a good one to focus on is the operating margin, also known as the EBIT margin (earnings before interest and taxes). These are the earnings that take into account the company's operating expenses, and this can tell us how much the company is spending to operate the business. I mean, let's face it, earning $1 million isn't going to mean much if it costs you $950,000 to do it. So how do these two compare? Here are the figures:

 

TTM

2010

2009

2008

2007

5-Year Avg.

Home Depot

8%

7.5%

7.4%

9.4%

11%

8.8%

Lowe's

7%

6.8%

7.9%

9.8%

11%

8.5%

Source: Capital IQ, a division of Standard & Poor's.

Home Depot squeaks one out over Lowe's when it comes to operating margins. But they both make the smaller rival Tractor Supply Co.'s (Nasdaq: TSCO) 5.9% average look like it needs to get in gear.

Free cash flow margin
Finally, I like to take a look at the free cash flow margin. While slightly more involved, it can really shed light on what the company is actually making once it is all said and done. Free cash flow is one of our favorite numbers to look at. Simply defined as cash flow from operations less capital expenditures, free cash flow is that money that is left after all of the bills have been paid. It is the money that the company can return to shareholders in one fashion or another. Be it in the form of dividends, share buybacks or even reinvesting in the business. The free cash flow margin is a comparison of the free cash flow the company is generating to its revenues. Let's see how the two match up:

 

TTM

2010

2009

2008

2007

5-Year Avg.

Home Depot

6.2%

6.3%

5.2%

2.8%

5.2%

5.1%

Lowe's

3.6%

4.8%

1.8%

0.7%

1.3%

2.4%

Source: Capital IQ, a division of Standard & Poor's.

A pretty significant difference here; Home Depot wins this battle hands-down.

And the winner is ...
All things being equal, when we consider these three metrics in assessing both businesses, I give Home Depot the edge here as it bests Lowe's in all three categories. While these aren't the only metrics to consider when assessing a business, they can provide a good starting point for further research. To be sure, both are quality businesses and worthy of consideration. But on this day, Home Depot is the Foolish winner.

Inside Value analyst Jason Moser owns no shares of any companies mentioned in this article. Home Depot and Lowe's are Motley Fool Inside Value picks. The Fool owns shares of Lowe's. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.