Note: All data are as of the close of Friday, January 2, 2015. Emphasis is on company fundamentals and financial data rather than commentary.
Today's competition is a rather interesting play on the shift in the housing market from new to renovation.
As evidenced in the graphs below, construction and sales of new homes in the U.S. have slowed over the past year or so, flatlining at around the 1 million units per year level for new home construction, and at just over 400,000 units per year for new home sales.
It stands to reason, therefore, that if America is building 1 million new homes per year but selling only 400,000 new homes per year, there is going to be a glut of vacant new homes on the market in the near future, which will slow the need for constructing new homes for a while.
But one area of the housing market slowly closing its doors (namely construction) means that another area is going to be gradually opening its doors (namely renovation). Hence, investors might expect the housing cycle to shifting from construction to renovation, setting the home improvement stores industry up for a rather nice spurt of growth soon.
What is more, rising interest rates, which are expected to begin their slow climb toward normal levels over the next few years, should further cool the new home market and further warm the renovation market, as more and more home owners will likely opt to renovate their current home for cheaper, rather than upgrading to a newer home all together.
This means the recent run-up in home renovation stocks should continue, likely even more robustly than it has during the recovery so far. Since both the economic recovery and housing recovery began at roughly the same time in early 2009, the nation's three largest home improvement stores - The Home Depot, Inc. (NYSE: HD), Lowe's Companies Inc. (NYSE: LOW), and Lumber Liquidators Holdings, Inc. (NYSE: LL) - have risen right along with the broader market, as graphed below.
Where the S&P 500 index [black] has risen 205% and the SPDR Home Builders ETF (NYSE: XHB) [blue] has risen 312%, all three of our featured stocks have beaten both benchmarks outstandingly - with LOW [purple] building itself up 395%, HD [beige] hammering up 465%, and LL [orange] nailing the 800% level.
On an annualized basis, where the S&P has averaged 35.65% and XHB has averaged 54.26%, LOW has averaged 68.70%, HD has averaged 80.87%, and LL has averaged 139.13% per year!
Note as well how all three featured stocks have risen rather dramatically over the past 6 months since the summer of 2014, indicating the shift from construction to renovation has already begun working its way through to our three stocks.
Looking at future earnings growth, the home improvement stores industry is expected to build its earnings very robustly versus the broader market's average earnings growth, as tabled below where green indicates outperformance while yellow denotes underperformance.
During the current and next quarters, the industry's earnings are expected to grow as some 2.14 to 3.24 times the S&P's average growth rate, maintaining a mid-range average of 2.34 times throughout 2015, before slowing to a more sustainable 1.65 times annually over the next five years.
Zooming-in a little closer, the earnings growth rates of the three largest U.S. companies in the space look even better than their industry's average over the longer term, as tabled below.
Over the near term, where LL is expected to under-grow the broader market's average earnings rate, both HD and LOW are seen outperforming at an impressive 1.16 to 2.20 times.
Yet over the course of 2015 and beyond, all three contestants are expected to outperform the broader market significantly, ranging from 1.73 to 2.56 times the S&P's average growth rate. The future belongs to the renovators.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, LOW delivered the greatest revenue and earnings growth year-over-year, while LL delivered the least, even earnings shrinkage.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, HD operated with the widest profit and operating margins, while LOW contended with the narrowest.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, LL's management team delivered the greatest returns on assets, while HD's team delivered the greatest returns on equity by a significant degree. At the low end of the scale, LOW's team delivered the lowest returns in both.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, HD provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while LOW's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, HD's stock is cheapest relative to forward earnings and 5-year PEG, while LL's is cheapest relative to company book value. At the overpriced end of the spectrum, HD and LL reciprocate their previous standings and the most overvalued stocks.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, LL offers the highest percentage of earnings over current stock price for the current quarter, while HD offers it for the remaining periods. At the low end of the scale, LOW offers the lowest percentage for the current quarter while LL offers it for the remaining periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, LOW offers the greatest growth from the current quarter through 2015, while LL offers it over the next five years. At the low end of the spectrum, LL offers the slowest growth near term while HD offers it for the whole of 2015 and over the next five years.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe LL's stock offers the greatest upside potential and greatest downside risk, while HD's stock offers the least upside and least downside.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, HD is best recommended with 8 strong buys and 11 buys representing a combined 61.29% of its 31 analysts, followed by LOW with 6 strong buy and 9 buy ratings representing 51.72% of its 29 analysts, and lastly by LL with 2 strong buy and 6 buy recommendations representing 47.05% of its 17 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… HD by a towering lead, outperforming in 14 metrics and underperforming in 4 for a net score of +10, with LOW finishing lower, outperforming in 10 metrics and underperforming in 10 for a net score of 0, leaving LL in shambles by comparison, outperforming in 7 metrics and underperforming in 17 for a net score of -10.
Where the home improvement stores industry is expected to outperform the S&P broader market substantially this and next quarters, significantly in 2015, and meaningfully beyond, the three largest U.S. companies in the space are expected to split perform in earnings growth near term, with LL under-growing the broader market's growth rate where HD and LOW out-grow it. For 2015 overall, as well as over the longer term, all three companies are then expected to outperform the S&P's average growth rate very constructively.
Yet after taking all company fundamentals into account, Home Depot Inc. builds the sturdiest financials given its lowest stock price to forward earnings and 5-year PEG, widest profit and operating margins, highest return on equity, highest EBITDA over revenue, highest diluted earnings over current stock price, highest future earnings over current stock price overall, highest dividend yield, best low price target, and most analyst strong buy and buy recommendations - handily winning the home improvement stores industry competition.