Personal Finance

Better Buy: Wal-Mart Stores Inc. vs. Home Depot Inc.

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It may be hard for today's youth to believe, but it wasn't that long ago that both Home Depot (NYSE: HD) and Wal-Mart (NYSE: WMT) were uber-growth stories. Yes, there indeed existed a time where home improvement stores were run by local outfits, and rural America was served first and foremost by mom-and-pop retail stores.

That helps explain why these two stocks created such immense value for shareholders as they were building out their kingdoms. Consider that in their first 15 years as public companies, Wal-Mart and Home Depot returned 21,000% and 46,000% to shareholders, respectively!

But that was then, and the past matters little to the stock market -- which is a forward-looking machine. While we can't determine which of these two stocks is a better buy today with 100% precision, there are a number of different lenses we can use to get a better idea for what we're buying ... and make a decision from there.

Financial Fortitude

When shareholders own companies like Home Depot or Wal-Mart, they likely want almost all of the company's extra cash to be returned to shareholders in the form of dividends or share buybacks. But we shouldn't overlook the power of a well-stocked war chest.

When difficult economic times hit -- and they will hit again some time in the future -- companies with cash on hand have options: They can outspend rivals, buy back shares, or even make acquisitions on the cheap. Those that are debt-heavy simply don't; they must scrape together everything they can to just avoid bankruptcy.

Here's how Wal-Mart and Home Depot stack up in terms of financial fortitude.

Company Cash Debt Net Income Free Cash Flow
Wal-Mart $7.7 billion $42.7 billion $14.7 billion $21.2 billion
Home Depot $3.6 billion $22.3 billion $7.7 billion $8.4 billion

Data source: Yahoo! Finance

Keeping in mind that Wal-Mart's value is roughly 30% higher than Home Depot's, I think a strong case can be made that the former is in a much stronger position than the latter. While I'm not particularly fond of either company's cash-to-debt ratio, Wal-Mart is clearly a cash-printing machine. It's no small feat to rake in over $20 billion in free cash flow (FCF) in a single year.

Winner = Wal-Mart

Sustainable competitive advantages

The simplest way to describe a sustainable competitive advantage -- often referred to as a "moat" by those in the investing community -- is to say that it is the thing that separates it from the competition. It's the special sauce that keeps customers coming back day after day, month after month, year after year.

In the past, Wal-Mart's moat was provided by its massive scale. Because it has so many locations -- both nationwide and around the world -- it can negotiate rock bottom prices from vendors, and pass those savings along to customers. But that moat has been assaulted in the past decade, as e-commerce sites eat up more and more of Wal-Mart's business.

While the company does have an Internet presence, it pales in comparison to what has been able to accomplish. Indeed, by offering an even more convenient shopping experience -- and relatively competitive pricing -- Amazon has been able to turn Wal-Mart's key advantage into its biggest liability. The company's brick-and-mortar locations now represent an expense that Amazon doesn't have to worry about.

Home Depot, on the other hand, benefits from both its scale and the nature of the product it sells. Unlike the home goods that both Wal-Mart and Amazon offer, there isn't a strong e-presence for large home-improvement purchases. Customers often like to look at, handle, test out, and leave the store with the products they are buying at Home Depot. While the company does have competitors in this realm, it does not face the same type of disruption Wal-Mart does.

Winner = Home Depot


Finally, we have valuation. This isn't an exact science, but here are the metrics I like to consult to get a better idea for how expensive a stock is.

Company P/E P/FCF PEG Ratio Dividend FCF Payout Ratio
Wal-Mart 15 10 3.0 2.8% 32%
Home Depot 22 20 1.6 2% 39%

Data source: Yahoo! Finance, E*Trade, Nasdaq.

While Home Depot does appear cheaper than Wal-Mart on the one metric that does take potential growth into consideration (PEG Ratio), Wal-Mart comes out ahead in almost every other category. The fact that it has a fatter dividend is the icing on the cake that makes me give Wal-Mart the nod here.

Winner = Wal-Mart

So there you have it: Wal-Mart is the better buy today. But that doesn't mean I think you should go out and buy shares now. While I find Home Depot's moat to be more impressive, it's hard to argue with the price tag that Wal-Mart is selling for right now.

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Brian Stoffel owns shares of The Motley Fool owns shares of and recommends The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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