Today I want to consider two more great companies, Home Depot (HD) and Lowe’s Companies Inc. (LOW). It is sometimes difficult to choose between two remarkable companies like these. Perhaps this is why no less than eight guru investors have chosen to hold positions in both.
Dodge & Cox
Further, currently a total of 17 guru investors have taken a position in Home Depot (HD) and 13 have taken a position in Lowe’s (LOW). They are popular stocks with elite investors. As I began my research after choosing these two stocks, I was fearful that we may get down to nothing more than a distinction or likeness between the aprons of Home Depot or the vests of Lowe’s. Personally, I’m more of a vest guy.
The economic downturn has been a key factor in some of the lackluster results for these two companies and any further news of increasing unemployment or any deterioration in the housing recover (if you believe in one) will takes its toll on the companies and discourage consumers from maintaining or improving their homes. It has been estimated that just fewer than 25% of homeowners owe more than their homes are worth. This makes home improvement purchases nearly impossible and the potential for any type of equity loan out of the question. This remains a huge risk to both companies.
I have a friend and fellow investor that keeps insisting that the economy has bottomed out and that the near future of these two companies is nothing but upward. In fact, he insists that things will turn around 360 degrees. I always chuckle and remind him the 360 degrees (for any of you that are degree challenged) leads you right back to where you were… the bottom.
When the article about Walmart and Target was written, I displayed a simple chart indicating the size of various companies by market capitalization in order to get a perspective on the incredible size of Walmart in comparison to Target and other leading companies. Oddly enough, I included the two companies we are scrutinizing today. At the time of the article, the market capitalization for both companies was:
Home Depot: $ 57.50 billion
Lowes: $ 35.21 billion
The numbers currently indicate the following change in capitalization:
Home Depot: $ 77.63 billion (approx. 35% increase)
Lowes: $30.35 (approx. 14% decrease)
So, perhaps Home Depot has fared better, but as value investors we understand that it is no prediction of how the future may look.
As in the original article, I decided to take a stroll through both stores to see if there was something that stood out and separated it from its competitor. Once again, with Peter Lynch as my inspiration for checking things out personally and discussing both companies with friends and customers alike, I made the following observations:
People had their favorite between the two, but were unable to state any reason for their favoritism other than “just because”. No, I wasn’t interviewing teenagers.
Fully one half maintained that Home Depots prices were lower, while the other 50% concluded that it was Lowe’s that maintained an edge. Online, I checked various items, discovering that it appeared to completely depend on the item chosen. One store was lower in one area, the next item; the other store had the advantage.
Lowe’s stores appearance edges out that of Home Depot to the many I spoke to. I would concur with that assessment.
Employees were generally helpful in both stores and knowledgeable, however; Home Depot’s employees apparently thought my wife and her sister were very pretty because they kept following them around, while Lowe’s employees eyed me suspiciously when I told them I wasn’t buying anything and that I just wanted to check out their store.
Going back to the original article and checking the debt, we can see that the debt structure of both is similar. I had mentioned an approach that I like in looking at debt in the book “The New Buffett-ology,” though there are many such metrics to explore to get a full picture. Five times net current earnings in excess of long term debt separates those companies with a competitive advantage. Stated another way, long-term debt burdens should be fewer than five times current net earnings.
This is a tough call; however, I give the edge to Lowe’s.
A place in which they did differ was in the area of margins, in which I would give the edge to Home Depot, especially in the current economic climate when it comes to squeezing out profits as much as possible. The higher margins will potentially allow Home Depot to pressure the returns of Lowe’s, though the advantage is slight.
We also discussed three major metrics that investors use to find economic moats that separate them from their competitor. These were return on equity, return on assets and return on invested income.
Return on Assets is important for discount retailers because if you cannot raise prices easily, asset turnover will allow you to increase your profitability. ROA measures how efficiently you can turn assets into profits. Typically, you want to see a ROA minimum of 7% and consistently. Advantage… Home Depot.
Return on Equity measures how well companies are generating good returns on the shareholders’ money. Once again, consistency is important and any number over 15% is considered exceptional and an indication of an economic moat. The higher the better. Advantage… Home Depot.
Return on Total Capital is considered extremely important to the Buffett line of thinking according to “The New Buffett-ology.” Because price competitive companies can be financed with debt several times their equity, a high ROE may still be indicated. Therefore, Buffett likes to go further by seeing an ROTC of at least 12%, along with the high (15%+) ROE. In this article, we will use the ROC from GuruFocus based upon Joel Greenblatt’s methodology. Advantage… Home Depot
These are two terrific companies with lots of potential; however, I believe both of them to be currently overvalued. With that said, one should always keep a list of top stocks handy that indicate a lot of strength so that if the market decides to value them less than what the intrinsic value may be, one can be ready to jump on the opportunity. Truthfully, while I give the edge to Home Depot, they are both on my list.
Disclosure: No positions.