How to spot a dubious investment when stocks are over-performing

By Tomás H. Lucero

Lowe’s and Home Depot investors are happy campers right now.

Both home-improvement stocks have been dynamite. Over the past year, Lowe’s has risen by 61 percent and Home Depot’s by 48 percent. To an investor looking for his next opportunity, Lowe’s appears to be, hands-down, the best company to buy into at the moment. A closer look, however, tells a more complex story that may provoke an investor to think twice before buying into a stock based solely on its recent upturns.

For example, even though Lowe’s stock rose by 13 percentage points more than Home Depot’s, according to the Wall Street Journal, the latter store produced better results in number of sales and rate of revenue growth. This means that, as long as Home Depot continues to do better in these indexes, in the long run, Home Depot may not be as inferior a competitor as some numbers may show.  

A look at both companies’ compound annual revenue growth (CARG) also takes some gloss away from Lowe’s stock price promise. Over the last five years the CARG for Lowe’s is 3.8 percent and for Home Depot it’s 4.7 percent. And glaringly, Lowe’s operating margin is 8.6 percent, compared to its rival’s 12.6 percent. Operating margin is an important indicator about how well a company is running its business in day-to-day operations.  By comparing gross margin, an important factor in operating margin, allows insight into the expenses of returns of merchandise and discounts that marketing has given its customer base to drive sales. It also shows how well an organization is absorbing depreciation and managing its tax obligations. The numbers show that Home Depot is outperforming Lowe’s in these nuts and bolts of business.

Another important factor in weighing these two stocks is that, as the Wall Street Journal points out, “The problem is that a strong economic backdrop already is factored into the share prices of both companies.” While this factorization is needed, it also lends the value of the stock a dash of capriciousness. If the “strong economic backdrop” continues—in this case, in housing—then the stock will continue its gallop. If the prediction is wrong, the stock may trip.  

This is not an endorsement of Home Depot stock. Both companies are doing well in some important ways. This is not reason enough to run out and buy into them, or any company, that looks great on the surface.

*This article is not intended as financial advice or brand endorsement. Please consult a professional when making investment decisions.

Related Story: Home Depot’s Frank Blake Steps Down, New CEO Appointed

Related Story: The benefits that big data and analytics afford retailers}

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