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Home Depot Vs. Lowe’s: HD Passes Buffett’s $1 Reinvestment Test – Seeking Alpha

M. Suhail

Introduction

In this article we evaluate the relative value of Home Depot Inc. (NYSE:HD) and Lowe’s Companies Inc. (NYSE:LOW) from a business owner’s perspective. Employing a business owner’s perspec…….

M. Suhail

Introduction

In this article we evaluate the relative value of Home Depot Inc. (NYSE:HD) and Lowe’s Companies Inc. (NYSE:LOW) from a business owner’s perspective. Employing a business owner’s perspective to investing is a style of value investing popularized by Warren Buffett among others. One important aspect of a business owner’s perspective to investing is looking closely at the management decision of how much of the earnings to pay out in the form of dividends and how much to retain. In particular, we will evaluate the two companies with a framework suggested by Mr. Buffett in his 1984 letter to Berkshire Hathaway shareholders. In the letter, Mr. Buffett stated:

“For a number of reasons managers like to withhold unrestricted, readily distributable earnings from shareholders – to expand the corporate empire over which managers rule, to operate from a position of exceptional financial comfort, etc. But we believe there is only one valid reason for retention. Unrestricted earnings should be retained only when there is a reasonable prospect – backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future – that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.” – Source: Berkshire Hathaway, 1984 Letter to Shareholders.

Earnings

Please look at Table 1 in which we look at the inverse of the P/E ratio for Home Depot and Lowe’s. The earnings yield has the benefit of quantifying what return at the current price can the investor expect. Earnings per share represent profits that is due to the shareholders. The management of the firm, entrusted with shareholder capital, decides how much of the capital to pay out in the form of dividends and how much to keep and reinvest in the business which, in theory, will ultimately benefit shareholders. From this table it appears that Lowe’s is the better deal. Investors today will get 111 basis points more yield from investing in Lowe’s than Home Depot, ceteris paribus.

Table 1: Earnings Yield
Home Depot Lowe’s
Price $ 296.32 $ 201.07
Forward earnings estimate (Jan. 2023) $ 16.58 $ 13.50
Earnings yield 5.60% 6.71%

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Source: https://seekingalpha.com/article/4538373-home-depot-vs-lowes-hd-passes-warren-buffett-reinvestment-test

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