Term Paper on "Home Depot"

Term Paper 7 pages (2033 words) Sources: 1+

[EXCERPT] . . . .

While both companies carry roughly the same product lines, Home Depot is more active internationally. This bodes well for the company, because its income streams are likely going to be less variable than those of Lowe's. The betas of the two companies seem to indicate this as well. Furthermore, Home Depot is the larger of the two, and that has implications for scale as well. There is little to choose between these two companies in terms of their shopping experience. The firm that a customer chooses is likely the one that is closer to home, or perhaps has better service. If Home Depot can use its scale to achieve better buying power than Lowe's, then it can outcompete Lowe's on prices, while maintaining roughly the same gross margins. Remember than the operating margin for Home Depot is already superior, in that Home Depot experiences scale savings on its operating expenses.

To choose between these two companies for investing, I would choose Home Depot. In the short run, Lowe's might continue its run of outperforming, but even that looks like a questionable proposition. Home Depot at this point has a lower forward P/E ratio, even though it is experiencing strong growth and has better metrics across the board. There is no area where Lowe's is demonstrably superior in terms of its finances than Home Depot. Furthermore in the long run Home Depot has experienced the superior stock market returns.

A further reason to invest in Home Depot over Lowe's relates to the dividend policy. Lowe's offers most of its earnings back to its customers as dividends. The problem with that approach is that it reduces the capital available to management for expansion. Home Depot, which retains more of its earnings, is in a much better position to reinvest in its business. As a result, Home Depot is more likely to see capital gains over the coming period.

Further qualitative factors should include the past performance of the stock, which is generally good for Home Depot. The company withstood the recession, albeit with some layoffs, but the market recognized strong performance from the company during that period. Home Depot's efforts at streamlining have resulted in the company having a lower rate of expenses than Lowe's does, and the market has rewarded Home Depot's cost management success with superior performance. Over time there should be a link between this performance and the valuation that the company receives.

In conclusion, financial statement analysis provides us with the opportunity to break down the statements of comparable companies to see which one is genuinely the better investment. For example, here we have Lowe's, which over the past year has outperformed Home Depot significantly. The preponderance of data, however, suggests that Home Depot is the superior company in terms of its financial performance. If this is not currently reflected in the stock price, it has been historically over the past five years, where Home Depot has been the superior performer both on an absolute and a risk-adjusted basis. There is no logical recommendation to make other than to invest in Home Depot. The company is the better-run of the two, it has the better numbers, and it… READ MORE

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