One quarter ago, I said I favored Lowe's (NYSE:LOW) over Home Depot (NYSE:HD), as I thought the difference in valuation outweighed the difference in quality between the two companies. So far, so good, with that call, as Lowe's basically doubled Home Depot's return for the past three months. While I do worry that both stocks are a little expensive on the basis of investor optimism for a housing recovery, I won't rule out the idea that an improved business plan coupled with improving sales trends will be a powerful boost to earnings and cash flow for Lowe's over the next few years.

Applying The MACD Indicator With MetaTrader 4: How to use MetaTrader 4, a trading platform used for online trading in the forex, CFD and futures markets.

Solid Progress in Q3
Lowe's logged good performance in the third quarter, though admittedly not as strong as Home Depot's performance for the same period. Still, Wall Street is a realm of relative expectations and nobody expected Lowe's to top Home Depot.

Revenue rose about 2% for the quarter, with comps up 1.8%. Not only is that an improvement from last year's 0.7%, but it's also an improvement over the recent trends, and it represents pretty meaningful upside to analyst estimates that seemed to cluster around 1% (and some predicted a drop in comp sales).

Profits continue to improve as the company nears the end of its adjustments to merchandising and inventory management. Gross margin improved about 15 basis points, the first expansion in about a year and a half. Adjusted operating income rose about 3%, and Lowe's delivered a solid beat.

Sandy + Recovery + A New Plan
Lowe's should have plenty of tailwinds pushing it along for the next few quarters. The recovery/rebuilding efforts in the wake of Sandy should offer a triple-digit boost to comps, particularly given the agreement between Lowe's and the state of New Jersey.

Beyond the storm recovery, there are ample signs that there is a real (if still slow) recovery in the residential housing market. Companies like Louisiana-Pacific (NYSE:LPX) and Weyerhaeuser (NYSE:WY) are getting more optimistic (even if cautiously so), and new building and remodeling activity do appear to be picking up.

Last and not least, Lowe's new pricing and merchandising approaches should lead to better sustained traffic patterns. Couple a recovery in demand for home improvement products with better traffic and perhaps more store-brand merchandise on the shelves, and Lowe's could be looking at some solid years to come.

But There's Still Work to Be Done
I'm optimistic that Lowe's will fix what has been ailing the company and close some of the gap with Home Depot. However, it's worth remembering that the gap is not inconsequential.

Lowe's had 1.8% comp growth this quarter, while Home Depot had 4.2%. What's more, this was the first time in a little while that Lowe's was less than 300bp behind Home Depot in comps. While the gross margins are quite similar (34.3% for Lowe's this quarter and 34.6% for Home Depot), the adjusted operating margins, when analyzed, are quite different, as Home Depot has a roughly 350-basis-point advantage (up from about 275bp last year).

The point here is not to bash Lowe's for its shortcomings, nor to assume that the company will quickly close the gap, but just to offer a reminder that Lowe's has both opportunity and risk when it comes to its model and the relative performance it has been producing.

The Bottom Line
As I said in the intro, I thought Lowe's was the better relative value and had more upside potential if its own self-improvement and remodeling plans worked out well. I still believe that to be the case, but the performance of both stocks has been pretty solid over the past year. Consequently, I would be in no hurry to jump off the bandwagon, but I'm not sure I'd chase these stocks right now.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  2. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  3. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  4. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  5. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  6. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  7. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  8. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  9. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  10. Stock Analysis

    The Biggest Risks of Investing in Amazon Stock

    Find out which risks are most important to Amazon's shareholders. Learn which operational risks impact share prices and which financial risks affect investors.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!