Home Depot And Lowe's: Fast-Growing Super SWANs Worth Buying Today

Summary

• Companies that can sustain rapid dividend growth for many years or decades are a great way to exponentially grow both your income and wealth.
• Over the last 33 years Home Depot and Lowe's have minted many a millionaire, and today represent two level 11/11 quality Super SWAN dividend-growth stocks.
• These companies have great businesses, excellent management, and long-term double-digit earnings and dividend-growth potential.
• At today's valuations, I can recommend buying both, with HD and LOW being about -2% and 11% undervalued and offering roughly 13% and 19% CAGR long-term total return potential, respectively.
• Just remember that risk management and proper asset allocation are the most important component of good investing returns. Always own any stock as part of a well diversified portfolio that meets your personal needs.

(Source: imgflip)

Nothing's better than a quality company that is able to compound investor wealth at an incredible rate over decades. Except, perhaps, if these companies also pay safe and fast-rising dividends, which allows you to pay the bills during retirement without having to sell your exponentially appreciating shares. But to recognize such companies isn't always easy, which is why Benjamin Graham, Buffett's mentor, the father of value investing, and one of the greatest investors in history (20% CAGR returns from 1934 to 1956 vs S&P 500's 12%) offered this advice in "The Intelligent Investor"

“One of the most persuasive tests of high-quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the last 20 years or more is an important plus factor in the company’s quality rating.”

Well, Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) are two hyper dividend-growth stocks that, as Graham might have predicted, have a great track record of enriching investors over the decades.

Home Depot and Lowe's Total Returns Since 1986

(Source: Portfoliovisualizer) - note portfolio 1 is Home Depot, portfolio 2 is Lowe's

$10,000 invested in either company 33 years ago would have made you a millionaire and in the case of Home Depot, a deca-millionaire (and in the top 0.09% of all Americans by net worth). Of course, past performance is no guarantee of future results, but there are plenty of reasons to believe that both Home Depot and Lowe's will be able to deliver safe and rapidly growing dividends, as well as market-beating total returns for years if not decades to come.

From today's valuations, I consider Home Depot a decent "buy" and Lowe's a "strong buy" because they are approximately fairly valued, and 11% undervalued, respectively. Given their realistic long-term growth prospects, that should allow HD and LOW to deliver roughly 13% and 19% CAGR total returns over the coming five years. Those kinds of strong market-beating returns make these two dividend-growth legends worthy for consideration for a spot in your diversified income portfolio.

Home Depot: The Industry Gold Standard

The first thing I always look at with any company is its quality, specifically the dividend safety, business model and whether or not management has a proven track record of good capital allocation and dividend friendliness.

• Dividend Safety Score: 5/5
• Business Model: 3/3
• Management Quality: 3/3
• Total Quality Score: 11/11 (Super SWAN)

Home Depot is one of the highest quality companies in America, earning a perfect score on my 11 point quality scale, making it a Super SWAN (as close to a perfect dividend stock as exists on Wall Street).

Company	Yield	TTM FCF Payout Ratio	Simply Safe Dividends Safety Score (Out of 100)	Sensei Dividend Safety Score (Out of 5)	Sensei Quality Score (Out of 11)
Home Depot	2.6%	49%	87 (Very safe)	5 (Excellent)	11 (Super SWAN)
Safe Level (by industry)	NA	60% or less	61 or higher	4 or higher	8 or higher

Click to enlarge

(Sources: Simply Safe Dividends)

The excellent dividend safety is courtesy of a modest FCF payout ratio, as well as a great balance sheet. Management's official dividend policy is targeting 55% of last year's EPS.

Company	Net Debt/EBITDA	Interest Coverage Ratio	S&P Credit Rating	Average Interest Cost	2018 Return On Invested Capital
Home Depot	1.7	15.0	A	3.8%	45%
Safe Level	3.0 or below	8 or above	BBB- or higher	below ROIC	8% or higher

Click to enlarge

(Sources: Simply Safe Dividends, F.A.S.T. Graphs, Gurufocus, Morningstar)

The company's net leverage ratio is far below the safe level for this industry, and its interest coverage ratio is nearly double the safe limit. This earns Home Depot an "A" credit rating from S&P and allows it to borrow at nearly 12 times less than its sky-high returns on invested capital (a proxy for good management and source of organic growth).

(Source: investor presentation)

Home Depot's return on invested capital has consistently been not just the best in the industry, but climbing steadily over the past decade and is among the highest of any company in America. While ROIC can be cyclical and decline during recessions, Morningstar estimates that the company should be able to maintain long-term ROIC of 40% over time, which is in line with management's 2020 goals (and was achieved in 2018).

This highlights the quality of its management, led by CEO Craig Menear, who has been in that role for five years. Menear has been with the company for over 20 years and has experience in all aspects of the business including merchandising, supply chain, store operations, sourcing, marketing and online retail.

(Source: Simply Safe Dividends)

Not surprisingly, this cash minting company's dividend track record is excellent. Yes, it froze its payout during the Great Recession, but Home Depot has paid steady or fast-rising dividends for over 30 years, including a 32% hike for 2019.

(Source: investor presentation)

While 2019 is not going to be a strong growth year for the company (partially due to tough comps from 2018's tax reform induced 34% earnings jump), the company remains a great long-term dividend-growth story.

Home Depot's great profitability is due to its biggest competitive advantage, a dominant position in a wide moat and, at least thus far, Amazon (AMZN) resistant industry. The company was founded in 1978, literally inventing the big-box home improvement concept and today has 2,290 stores in the US, Canada, and Mexico (#1 market share in all three countries). Its $108 billion in 2018 sales makes it the largest home improvement retailer in the world.

But while Home Depot may be the industry leader, it commands just 18% total market share (and just 12% using Lowe's $900 billion TAM estimate).

(Source: investor presentation)

The new Pro (formerly interline) business (45% of total sales) serves the MRO industry via selling to professional renovators/remodelers, general contractors, handymen, property managers, building service contractors and specialists like electricians, plumbers, and painters.

Contractors are a richer source of sales per customer because of their more varied needs which give HD the ability to cross-sell them on many of its product offerings. In Q1 2019, transactions over $1,000 (about 20% of total sales and mostly contractor-driven) were up 3.9% (5.1% excluding last year's hurricane effects).

HD's size has given the financial scale to widen its moat, including the most efficient supply chain in the industry to stock between 30,000 and 40,000 items at its stores. These include the most popular and trusted brands in each product segment, which are sold by employees who are well trained and knowledgeable in helping customers address whatever their home improvement needs might be. The company also has exclusive arrangements with popular brands such as

• Husky hand tools
• Everbilt plumbing products
• Glacier Bay bathroom fixtures
• Life and Pet Proof
• Ecosmart lighting fixtures
• Vigoro lawn care products
• Stanley hand tools

The company also offers equipment rentals at 1,200 US and Canadian locations. Equipment rental is popular with contractors and better yet, most renters also end up buying more accessory products to support their projects, further boosting the company's sales. A few years ago just 10% of contractors rented equipment from Home Depot, but today that figure is 25%. This shows both growth in this particular business, as well as further room for improvement.

Between 2018 and 2020 HD plans to more than double its spending on investing in store improvements, employee training, online sales and winning market share in its Pro contractor focused business.

(Source: investor presentation)

Between 2018 and 2022, the company plans to build over 150 new fulfillment centers that will allow it to deliver same or next day delivery of online orders to 90% of the US population within three years.

This is part of its "One Home Depot" omnichannel model that seeks to create a fully integrated and seamless online shopping experience, from online search, including its mobile app, for purchase and in-store pickup (including from secure lockers). One Home Depot has already signed up over 135,000 contractors, which shows Home Depot's omnichannel execution is popular with both DYIers and professionals. In 2019, the company hopes to launch a new online Pro site and attract 1 million contractor customers. The company reported that online and self-checkout satisfaction scores were up 5% in the past year, a testament to the company's aggressive investment into streamlining its shopping experience.

In Q1 2019, Home Depot had already achieved same day/next day delivery to 70% of America's population and its online business (54% of all revenue from in-store pickup of digital sales) grew 23%, faster than Amazon. That's after 24% online sales growth in 2018, which means that about 8% of total company revenue is derived from digital.

(Source: Motley Fool) - green = easily disrupted by e-commerce

Home improvement is naturally e-commerce resistant because the low value and high weight of many popular home improvement products make them cumbersome and expensive to ship online (thus the reason for so much in-store pickup). This effectively means that Home Depot and Lowe's have less to worry about from online rivals because each possesses a massive installed base of well-located stores that give them an edge over companies that are trying to build out a logistics chain from scratch.

Home Depot's future looks bright due to a major secular economic trend, which would be decades of underdevelopment in US housing.

(Source: Hoya Capital Real Estate)

Even before the Great Recession gutted housing construction the average age of a US home had been rising since 1990 and is now 38, the oldest since the mid-60s. As any homeowner knows, all homes can be money pits, but especially so with older ones.

(Source: Hoya Capital Real Estate)

By the time a home is about 25 years old, maintenance can run about 3% of a home's value each year. This bodes well for Home Depot and Lowe's who are the most dominant names in home improvement.

Further boosting each company's long-term growth prospects is the fact that Millennials have finally stopped putting off family formation and home buying.

(Source: Hoya Capital Real Estate)

This means a massive increase in home demand is coming over the next decade, which should give all home improvement retailers a major growth tailwind. Contractors building those houses are why both companies are so focused on expanding their professional businesses.

Overall, analysts expect Home Depot to deliver about 4% long-term revenue growth, with efficiency improvements slightly boosting margins. Combined with its penchant for generous buybacks, that should lead to about 10% long-term EPS and FCF/share (and dividend) growth.

When combined with its 2.6% yield, that makes Home Depot a potentially great long-term income growth investment, with one of the fastest growth rates of any Super SWAN.

Lowe's: A Fast-Growing Dividend King With A Bright Future

Despite its turnaround challenges, I still consider Lowe's one of the highest quality dividend stocks you can buy.

• Dividend Safety Score: 5/5
• Business Model: 3/3
• Management Quality: 3/3
• Total Quality Score: 11/11 (Super SWAN)

That starts out with a bank vault safe dividend, courtesy of a safe payout ratio.

Company	Yield	TTM FCF Payout Ratio	Simply Safe Dividends Safety Score (Out of 100)	Sensei Dividend Safety Score (Out of 5)	Sensei Quality Score (Out of 11)
Lowe's	2.2%	41%	93 (Very safe)	5 (Excellent)	(SWAN)
Safe Level (by industry)	NA	60% or less	61 or higher	4 or higher	8 or higher

Click to enlarge

(Sources: Simply Safe Dividends)

It extends to a strong BBB+ rated balance sheet, with a safe net leverage ratio and good interest coverage.

Company	Net Debt/EBITDA	Interest Coverage Ratio	S&P Credit Rating	Average Interest Cost	TTM Return On Invested Capital
Lowe's	2.4	9.3	BBB+	3.7%	19%
Safe Level	3.0 or below	8 or above	BBB- or higher	below ROIC	8% or higher

Click to enlarge

(Sources: Simply Safe Dividends, F.A.S.T. Graphs, Gurufocus, Morningstar)

Management plans to retain safe debt levels that allow it to borrow well below its strong (though not as impressive as HD's) ROIC.

(Source: investor presentation)

Note that quality companies tend to deliver 8% or higher returns on invested capital and Lowe's is over double that amount.

(Source: Simply Safe Dividends)

But of course, what really sets Lowe's apart from Home Depot is its dividend king status, courtesy of 56 consecutive years of annual payout growth. And like Home Depot, the dividend-growth rate is impressive, including a 15% dividend hike for 2019.

Now I know that a lot of investors might wonder how Lowe's can be a "Super SWAN" when it recently suffered a double-digit single day price decline after a disappointing earnings report.

However, as I always point out in my articles, blue-chip and SWAN classification only applies to a company's quality and dividend safety. Even the legendary dividend aristocrats and kings inevitably suffer huge daily crashes, courtesy of the market's hyper focus on short-term results.

Dividend Aristocrats Single Biggest Daily Declines Since 2009

(Source: Ploutos Research) - data as of April 2019

Lowe's has now suffered two double-digit single day crashes in the past decade, but it's important to remember that typically these are good buying opportunities.

(Source: Ploutos Research) - data as of April 2019

Over the past 10 years, 80% of aristocrats and kings that have plunged 10+% in a day have recovered within a year (average return 32%, median return 33%). Lowe's last flash crash before this one was in 2012, and 12 months later it was up 69%.

That's not to say that buying strong dips in all Aristocrats is guaranteed to deliver 30+% one-year gains. This data set isn't statistically significant (too small) and many of these impressive gains were courtesy of the longest bull market in history. But my point is that even the bluest of blue-chips will eventually have a very bad day, and fall into a company-specific bear market.

I happened to buy a starter position Lowe's for my retirement portfolio on the day of its 12% crash, which was courtesy of management lowering guidance for 2019 over worse-than-expected execution on its long-term turnaround plan.

Specifically what upset Wall Street was the following revised 2019 guidance.

• operating margin expansion (due to turnaround): 3.25% (down from 3.8%)
• Adjusted EPS of $5.55 (down from $6.05, equals about 8% EPS growth this year)
• total sales growth of 2% (unchanged from 2%)
• same-store comps growth of 3% (unchanged from 3%)
• target debt/EBITDA ratio of 2.75 ($4 billion of buybacks planned for this year)

Now it should be noted that the trade war was partially responsible for this downward revision. Baird analyst Peter Benedict estimates that about 25% of the gross margin decline of 1.65% was the result of tariff-related expenses that might increase in the short term, but are unlikely to be permanent.

What about the rest of the disappointing guidance (which still shows good margin expansion)? As management explained in the Q1 conference call

The unanticipated impact of the convergence of cost pressure, significant transition in our merchandising organization, and ineffective legacy pricing tools and processes led to gross margin contraction in the quarter which impacted earnings....there was much more disruption in Q1 than we anticipated, and this disruption was primarily driven by a lack of visibility in our pricing ecosystem. Our new merchant simply did not have a clear line of sight to the cost increases that were accepted by prior merchants as we transitioned. Based on the assisted -- really limited system visibility, we could not quickly analyze and offset these cost increases with appropriate pricing action." - CEO Marvin Ellison

Basically, Lowe's is saying that its big turnaround effort, which is scheduled to last through 2023 and includes the largest executive shakeup in the company's history, is just getting started and involves massive logistical/supply chain challenges.

Keep in mind that most of Lowe's new executives, including the CEO (a former executive at Home Depot), have only been in their current jobs for six months. Over that time the company has gained

• 3 new board members
• A new chief digital officer poached from Amazon
• A new head of merchandising (formerly from Chevron (CVX))
• A new head of stores (experience at J.C. Penney (JCP) and Home Depot)
• A new supply chain head (previously from Walmart (WMT))
• A new CFO (from CVS)
• Replaced 2/3 of its merchandising senior vice presidents
• Replaced 11/13 of its merchandising vice presidents

The company's ambitious turnaround goals involve retraining over 280,000 employees, and making big changes to a supply chain that serves over 1,700 national stores and sells $72 billion of products (second-biggest home improvement retailer on earth). In effect, Ellison and his new team are facing a steep learning curve that requires coordinating the equivalent of a military campaign.

But what exactly is this vaunted turnaround plan that has me and most analysts convinced that Lowe's has a very bright future ahead of it?

(Source: investor presentation)

Lowe's is attempting to recreate Home Depot's success in integrated omnichannel as well as significantly improve its supply chain, boost time associates spend with customers (better customer service), and gain market share in the lucrative contractor market.

That's going to involve a lot of investment to achieve its long-term goals.

• $1.7 billion investment to revamp its supply chain (cut costs while improving efficiency)
• $1.5 billion to $1.65 billion investment into improved Omni-channel (including hiring 2,000 computer engineers so Lowe's can handle 80% of online sales in-house)
• reduce paperwork associates have to do (increase time with customers by 50%)
• Grow sales from professional customers (more loyal and make bigger purchases) to 20% to 25% of revenue

(Source: investor presentation)

Lowe's plans to build 79 new delivery terminals in an effort to boost its online sales platform. It also plans to triple the number of products offered on that platform to 1.5 million.

The ultimately goal is significant improvements in sales per square foot, revenue but most importantly margins and returns on invested capital.

(Source: investor presentation)

2019 is just the start of the company's long efforts to boost margins and ROIC, with most benefits not occurring until 2020.

(Source: investor presentation)

Ok, so that's an impressive PLAN, but as we just saw complex turnarounds inevitably run into problems. So why should investors trust this new management team can eventually deliver significant margin expansion and sustain double-digit cash flow and dividend growth in the future?

Well for one thing, Lowe's core stats were still strong in Q1, with 3.5% comps growth (positive comps in 10/13 merchandise departments and 16% growth in online sales) and 4.2% growth in its professional home improvement business. Those are actually very impressive comps (Home Depot put up 2.5% and 4.5% excluding negative one-time effects), especially given that in Q1 consumer confidence plunged due to the government shutdown.

I also consider the opinion of peers I respect such as Morningstar's Jaime Katz who has confidence in Ellison saying "in our opinion, Ellison brings a tremendous amount of retail knowledge to the business." Furthermore, taking into account the former experience of the new management team at Morningstar, one of the most conservative analyst firms covering Wall Street, ranks Lowe's overall management quality "exemplary." That's high praise given that the vast majority of management teams are merely "standard" on its quality scoring system.

Okay, so that's one analyst firm that really likes Lowe's management team, and the core stats were equal to or better than Home Depot's. But what about that big earnings miss? Doesn't that indicate that Lowe's turnaround might be going off the rails?

Here's Mrs. Katz's take on the rough Q1's results.

Massive alterations to the supply chain and technology in the year ahead could temporarily crimp free cash flow, given that increased capital expenditure efforts ($1.6 billion in 2019) could take some time to bear fruit. However, our confidence that Lowe's can capture profit growth is rising, as these new efforts to institutionalize processes that were inefficient, including labor management, reset efforts, and inventory controls, could squeeze meaningful operating margin expansion out of the business if they are implemented properly." - Morningstar (emphasis added)

Okay, so Morningstar is still bullish on Lowe's growth potential, but that's hardly definitive proof that investors should trust this company with their hard-earned money.

So how about the fact that Mr. Ellison bought 10,000 shares in the open market on May 24th, which seems like pretty good evidence that the new CEO thinks the plan remains on track. The stock was trading about $95 at the time, meaning that Lowe's new CEO put up almost $1 million of his own money betting that he could indeed deliver on the company's long-term growth goals.

Now it's true that Ellison was paid $14 million in 2018, and has a net worth of close to $20 million. So perhaps this is just a feint on his part, to make it look like he's super confident in a plan that most of Wall Street doesn't believe in anymore?

Except that Wall Street agrees with Morningstar and my assessment that Lowe's turnaround is likely to succeed. Here are the long-term growth consensus estimates (five years) according to FactSet Research:

• January 2019: 15.9% CAGR
• May 2019: 15.6% CAGR
• June 2019: 16.3% CAGR

Compared to the start of the year the consensus growth expectation has actually improved. While long-term forecasts are just educated guesstimates, the fact is that numerous other blue-chip companies who have run into trouble this year have seen their growth forecasts slashed by as much as 50%. But when it comes to Lowe's, the street remains more confident than ever that the company can deliver very strong earnings and cash flow growth (about 60% better than Home Depot's, in fact).

Even better news for Lowe's investors (including myself) is that we can still expect shareholder-friendly management to reward us with generous capital returns, of about $25 billion over the next three years.

(Source: investor presentation)

That includes the new 15% increased dividend and ample buybacks (the Board recently authorized up to $10 billion in buybacks).

I bought Lowe's primarily because I believe that management can continue the company's rich tradition of very safe dividends that grow at double-digits over time. Thus far I consider that thesis intact, and would happily add to my position should Lowe's tumble once more on a short-term Wall Street freakout.

That's because I believe in time arbitrage, meaning buying what Wall Street hates today, over short-term growth concerns, because I'm confident that in 5+ years FCF/share and dividends will be much higher.

Ultimately it's this patience and willingness to collect my safe and growing dividends while letting management work for me; that is why I expect Lowe's to deliver some of the best total returns of any dividend king over the next five years.

Valuation/Total Return Potential: Safe And Rapidly Growing Dividends Likely Mean Many Years Of Double-Digit Total Returns Ahead

I only ever recommend or buy companies if I think they can offer safe and growing dividends and market-beating total returns over time. This is why I look at yield, long-term growth potential and valuation.

I use the Gordon Dividend Growth Model (relatively effective since 1954 and what Brookfield Asset Management (BAM) and NextEra Energy (NEE) use). This postulates that over time total returns = yield + long-term cash flow/dividend growth with valuation changes cancelling out over time (as long as the business model remains intact).

Valuation mean reversion does occur over 10+ years but over 5-10 year periods that same return to historical fair value can have a big impact on total returns (which is why I never recommend stocks except at fair value or better).

Company	Yield	5-Year Expected Earnings Growth	Total Return Expected (No Valuation Change)	Valuation-Adjusted Total Return Potential (5-10 Years CAGR)
Home Depot	2.6%	10%	12.6%	9.9% to 17.0%
Lowe's	2.2%	16.3%	18.5%	16.3% to 21.0%
S&P 500	1.9%	6.1%	8.0%	1% to 8%

Click to enlarge

(Source: Simply Safe Dividends, management guidance, F.A.S.T. Graphs, Morningstar, management guidance, Yardeni Research, Yahoo Finance, Multipl.com, Gordon Dividend Growth Model, Dividend Yield Theory, Moneychimp, analyst estimates)

I consider the consensus growth estimates for Lowe's and Home Depot to be reasonable, given management's long-term plans, the secular trends facing their industries, and their historical growth rates.

If both companies can deliver on those growth rates then HD and LOW investors can expect strong double-digit returns, even ignoring valuation.

12.6% and 18.5% total returns would put to shame the market's historical 9.1% CAGR total return, the 8% that the GDGM expects from the S&P 500 over the next five years, and also the roughly 4% consensus that most asset managers believe is coming.

Asset Manager Expected Five to 10-Year Market Returns

(Source: Morningstar 2019 asset management survey)

But valuations always matter, so let's consider how P/E changes might affect investor returns.

(Source: F.A.S.T. Graphs)

Today both Home Depot and Lowe's are trading at slight discounts to their historical P/Es of 21.3 and 20.2, respectively. Assuming their PEs mean revert to those figures and both companies live up to current growth forecasts, investors would see about 13% returns from Home Depot and nearly 20% from Lowe's.

However, when it comes to my official valuation adjustment I turn to my favorite blue-chip valuation method, dividend yield theory or DYT. This has been the only approach used by asset manager/newsletter publisher Investment Quality Trends since 1966. DYT, which compares a stock's yield to its historical norm, has been the only approach IQT has used for 53 years, and only on blue-chips, to deliver market-beating returns with 10% lower volatility to boot.

(Source: Investment Quality Trends)

According to Hulbert Financial Digest, IQT's 30-year risk-adjusted total returns are the best of any US investing newsletter. Basically, DYT is the most effective long-term valuation approach I've yet found, which is why it's at the heart of my retirement portfolio's strategy and drives many of my article recommendations.

DYT merely compares a company's yield to its historical norm because, assuming the business model remains relatively stable over time, yields, like most valuation metrics, tend to revert to historical levels that approximate fair value.

Company	Yield	5-Year Average Yield	Estimated Discount To Fair Value	Upside To Fair Value	5-10 Year Valuation Boost (Compounded Annual Growth Rate)
Home Depot	2.6%	2.1%	19%	24%	2.2% to 4.4%
Lowe's	2.2%	1.8%	21%	26%	2.3% to 4.7%

Click to enlarge

(Sources: Simply Safe Dividends, Dividend Yield Theory, Gordon Dividend Growth Model, F.A.S.T. Graphs, management guidance, Moneychimp)

DYT estimates that both companies are about 20% undervalued, indicating approximately 25% upside to fair value. I can't tell you how long it might take for that return to fair value to happen, but it's likely to occur within five to 10-years. In which case the share prices could outpace cash flow/dividend growth by 2% to 5% per year.

I use DYT as one end of my valuation range, and Morningstar's intrinsic value estimates as the other, to minimize the chance of a thesis breaking event causing me to incorrectly recommend putting money (including my own) into a value trap.

Company	Current Price	Estimated Fair Value	Moat	Management Quality	Discount To Fair Value	Long-Term Valuation Boost
Home Depot	$207.48	$170 (medium uncertainty)	wide (stable trend)	Exemplary (excellent)	-22%	-1.3% to -2.5%
Lowe's	$99.31	$99 (medium uncertainty)	wide (stable trend)	Exemplary (excellent)	0%	0%

Click to enlarge

(Source: Morningstar)

As you can see, Morningstar disagrees with DYT in this case, and considers Home Depot overvalued and Lowe's merely fairly valued. To err on the side of caution, I average the two valuation estimates to conclude

• Home Depot: 2% overvalued (basically fair value)
• Lowe's: 11% undervalued

This makes Home Depot is a "buy" and Lowe's is a "strong buy" under my personal valuation scale. Of course, that's only for investors comfortable with their risk profiles and who buy them as part of a diversified and well-constructed portfolio.

Risks To Consider

Both Home Depot and Lowe's are economically sensitive and seasonal companies whose sales, earnings and cash flow can take a hit during recessions and due to various seasonal, weather-related and other short-term events. While these don't affect long-term growth potential, they can create severe headline risk (as Lowe's investors learned in Q1).

Even the might Home Depot suffered a short-term setback in Q1. The company's CEO noted in the Q1 conference call that February was the "second wettest on record" which, according to its CFO, resulted in 17 of 19 regions reporting negative comps that month.

Combined with a 58% decrease in certain lumber prices (a volatile commodity), revenues came in $200 million lighter than expected and drove down comps from 4.5% to just 2.5% (which disappointed many analysts). Management warned that should lumber prices not recover then 2019's full sales could come in $800 million lower (including Q1's miss).

And then there are the bigger negative medium-term effects of recessions to consider.

(Source: YCharts)

During the Great Recession, Home Depot's EPS (the thing Wall Street watches most closely) fell 49%, and Lowe's fell 30%. The next recession is likely to be far milder than the last one, which was the second worst downturn since WWII. But investors need to expect that both companies' fundamentals are going to take a hit during the next downturn, whenever it comes.

The bad news is that so far in 2019 we've seen a major slowdown in home improvement retail sales, due to the slowing economy.

(Source: Hoya Capital Real Estate)

The good news is that a recession isn't yet looming, based on where the 19 leading economic indicators are right now.

(Source: David Rice, aka "Economic PI")

David Rice has calculated over 30 years of economic data to determine their historical baseline levels and compares them to where the mean of coordinates or MoC (red dot) is relative to historical recessions. The current MoC, being 28.5% above baseline, is well above levels that would indicate a recession is near.

The latest leading indicator estimate (green dot, where MoC is likely to go) is actually showing continued positive growth.

That's also the consensus of all eight real-time GDP growth estimates, which are updated on a weekly basis as economic data comes in. Right now these models are tracking for 2% growth in Q2 (up from 1.8% last week) and the New York Fed's model is estimating 1.7% growth in Q3.

While growth is slowing, we're still a long way off from negative growth. The Fed also has eight rate cuts in its quiver, which Moody's Analytics estimates could boost GDP growth by about 1% within 12 months. The Fed has indicated it will cut to zero if necessary (and buy more long bonds via QE) to avert a recession.

(Source: New York Federal Reserve)

However, 12-month recession risk is rising and in May hit 30% to 35%, according to the Cleveland and New York Federal Reserves.

As Benjamin Graham wrote in his seminal work "The Intelligent Investor"

“The best way to measure your investing success is not by whether you’re beating the market, but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.” - Benjamin Graham

In other words, swinging for the fences and trying to achieve legendary returns (as these stocks have delivered) aren't always the optimal path. Risk management (including for recessions) is critical to maximizing your realistic returns and achieving your long-term financial goals.

Becoming financially independent doesn't require finding the next Home Depot (the current one is likely to make you plenty rich) but merely avoiding costly mistakes. Or as Charlie Munger, legendary value investor and Buffett's right hand at Berkshire (BRK.A) (BRK.B) for decades put it,

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

These are risk management rules of thumb that I've created based on nearly six years of research, and consultation with several asset managers, including some with decades of experience in the mutual/hedge and private equity fund industries.

The goal of these rules is to help you construct a portfolio that can both achieve sufficient long-term total returns to get you to your goals, but also avoid the kind of extreme volatility stocks are known for and which can result in panic selling at the exact wrong time. Here's what I mean.

50/50 Home Depot/Lowe's Portfolio Since 1986

(Source: Portfolio Visualizer)

This is what a 50/50 Home Depot/Lowe's portfolio would have accomplished since 1986. More than doubling the market's annual returns for a third of a century is remarkable, but notice the huge 63% peak decline, courtesy of a 48% crash in 2002 (a very mild recession).

While this portfolio's reward/risk ratio (Sortino ratio) is certainly excellent, few investors could have actually achieved these results because such a massive loss would have caused most people to panic-sell both quality stocks.

How do I know this? Because according to JPMorgan Asset Management, two 50+% crashes over the last 20 years, combined with horrible market timing, has caused the average investor to underperform every asset class, inflation and even a super conservative 40% stock/60% bond portfolio over half an investing lifetime.

So here's a better way of investing in both Home Depot and Lowe's, via a well-diversified and properly constructed portfolio suitable for the typical retiree/near-retiree. This model portfolio consists of

• Home Depot
• Lowe's
• Vanguard Dividend Appreciation ETF (VIG): a great low-cost ETF and proxy for dividend-growth stocks in general
• Invesco Ultra Short Duration ETF (GSY): a good low-cost ETF that serves as a cash equivalent
• Vanguard Total Bond Market ETF (BND): a good low-cost ETF that offers instant diversification to all investment grade corporate and government bonds

(Source: Portfolio Visualizer)

This is a traditional 60/40 stock/bond portfolio (including 10% cash equivalents) that is 15% in Home Depot and Lowe's. Here's how this portfolio would have done against the Vanguard Balanced Index Fund (VBINX), a proxy for the default 60/40 stock/bond portfolio (which the 4% rule is based on).

(Source: Portfolio Visualizer)

This portfolio would have slightly outperformed its benchmark, but with slightly lower volatility and a peak decline of just 11.3%. For context the S&P 500's peak decline was 19.8% during this time, meaning this portfolio allocation is far better for most investors, at least anyone for whom a 20% decline is terror-inducing.

Remember that the best-investing strategy is the one that's most likely to work for you personally. It balances your need for good returns with the ability to remain disciplined in the face of inevitable future market declines, including recessionary bear markets.

Bottom Line: Home Depot And Lowe's Are Two Fast-Growing Super SWANs Worth Buying Today

While neither Home Depot or Lowe's is the most undervalued blue-chip you can buy today, these level 11/11 Super SWANs are nonetheless great long-term dividend-growth investments.

They dominate their industry, which is highly fragmented and Amazon-resistant. What's more both also have the backing of a major secular trend, which is the fact that the US has been underbuilding homes for decades, and this will need to be corrected in the coming years.

Lowe's turnaround plan and weaker starting margins give it faster earnings/cash flow and dividend-growth potential, and thus makes it the superior choice for new money today. As does its superior valuation, roughly 11% undervalued vs. Home Depot's approximate fair value.

But given the quality of both companies, I can recommend opening or initiating a position in either, though I personally have only bought Lowe's for my retirement portfolio (where I keep 100% of my life savings) thus far.

However, never forget that all of my dividend stock recommendations are only meant for the equity portion of your portfolio (no dividend stock is a bond alternative). Make sure to own them as part of a well-diversified and constructed portfolio that is appropriate for your individual risk tolerance/goals and personal needs.

Disclosure: I am/we are long LOW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.