The home-improvement industry has been surging as the coronavirus pandemic has forced so many people to spend more time at home. Not only are they noticing more projects that need to be done, but since the home now needs to be an office, a school, and an entertainment center, they need to upgrade or overhaul existing spaces. On top of all that, data shows that more families are deciding to move out of cities and into suburbs — which means out of apartments and into houses.
While the changes in consumer behavior during the pandemic were good for the home-improvement industry overall, some companies are better equipped to take advantage than others. Here is why Home Depot (NYSE:HD) is a better way to invest in this change than Lowe’s (NYSE:LOW).
The outlook is bright for both Home Depot and Lowe’s, as consumers’ spending on their homes continues to take a larger share of overall spending. And while vaccinations against the coronavirus are under way, it may be a long time until everything is back to normal. That will give home-improvement retailers several more quarters of substantial revenue increases.
Moreover, one of the lasting consequences of the coronavirus pandemic is that more people are deciding that owning a home is a better bargain than renting an apartment. According to the Federal Reserve Bank of St. Louis, the homeownership rate in the U.S. is near its all-time high. Owners generally spend more on their homes than renters, which could fuel increasing revenue for the industry long after the pandemic has run its course. And with Home Depot having more physical locations than Lowe’s (2,295 versus 1,969), it’s more likely that these new homeowners will have a Home Depot nearby.
A physical presence has been considered a disadvantage for many retailers in recent years as e-commerce sales have expanded rapidly. That’s not the case for home-improvement warehouses because many of the products they sell are heavy and difficult to ship. Others are extremely time sensitive — not even Amazon can send you a product faster than you can pick it up at your local store (yet).
Valuation and performance
Home Depot is trading at a premium compared to Lowe’s — at Wednesday’s closing prices, Home Depot’s stock was valued at 23.7 times trailing-12-month earnings and 2.3 times sales. That compares to 22.6 times earnings and 1.3 times sales for Lowe’s.
But that can be justified considering that Home Depot is clearly more profitable, and that’s partly because Home Depot is so much better than Lowe’s at capital investment. Over the past two decades, Home Depot has spent less on capital investment as a percentage of revenue, compared to Lowe’s. And at the same time, its return on invested capital is consistently better. You can see both of those trends in the chart below.
And not only are Home Depot’s profit margins better than its competitor’s, but that advantage is generally getting larger, as you can see in the next chart. This points back to better investment decisions. What’s more, these capital investment decisions tend to be large in scale, and they can take years to implement and even more time to bear fruit. Therefore, they tend to be harder to copy from a rival and tend to build a longer-lasting competitive advantage.
What this could mean for investors
Since the start of the pandemic, sales are surging for both companies, but Home Depot is generating higher profit margins. In fact, it has been operating at higher margins for the better part of the last decade. Home Depot’s management has consistently made better capital investment decisions that will continue to bear fruit in the long run.
That trend could continue as its larger scale allows it to buy products at lower costs, generate better logistical efficiencies, and be closer to more of the population than Lowe’s. For those reasons, investors looking to buy a home-improvement stock should skip Lowe’s and go with Home Depot.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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