When To Buy Lowe's

Not that long ago, home improvement retailer Lowe's (NYSE:LOW) had no problem growing sales and earnings in excess of 20% per year. That trend quickly reversed course when the residential housing market peaked in 2005, and industry conditions have been dismal ever since. Investors are still waiting for a recovery and could use a higher margin of safety to be coaxed into investing in Lowe's stock.

IN PICTURES: 7 Ways To Position Yourself For Recovery

Free Cash Generation
During its last full fiscal year, Lowe's generated approximately $1.50 in free cash flow per diluted share. Despite an extremely challenging operating environment, in similar fashion to discount retail giant Wal-Mart (NYSE:WMT), cash generation has improved as the company has ramped down its new store growth. This trend will likely continue and should receive a further boost once home improvement spending trends turn consistently positive. One positive near-term data point stems from Fitch Ratings, which recently projected that home improvement spending will increase 3.5% this year.

While free cash flow generation may dip slightly for the current year, it should come close to matching earnings expectations that are currently pegged at $1.45 per share.

Valuation
Currently, growth expectations embedded in the current share price are pretty reasonable. Given the cash flow expectations, Lowe's needs to grow the bottom line about 6% per year to justify its current valuation. If it can again manage double-digit growth, then the stock could easily rise to more than $30 per share.

Wait and See
A share price below $20 per share offers a reasonable margin of safety with which to buy the stock. Sales and profit growth will eventually return to the home improvement industry, but tangible signs of a recovery have yet to emerge. After several years of waiting for a recovery after the bursting of the housing bubble, investors are accustomed to a wait-and-see-approach and will have to wait a bit longer. (Learn more, see: Why Housing Market Bubbles Pop.)

Bottom Line
At some point, industry spending levels will return to historic levels and more closely watch the growth in housing starts and demand for improving existing homes. This will benefit Lowe's as well as other industry constituents, including Pulte Homes (NYSE:PLT), Masco (NYSE:MAS), and Stanley Black & Decker (NYSE:SWK). A slightly lower share price offers better protection should the inevitable recovery take longer than anticipated.

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