Forget Home Depot: Buy This Stock for Dividend Growth Instead

Home Depot (NYSE: HD) has been a favorite on Wall Street through just about every stock market environment. That's because the leading home improvement retailer earns its premium by delivering steady market share gains, along with impressive profitability, in its fragmented industry.

Yet, there are better options available for income investors who might be disappointed by Home Depot's expensive price and its relatively short track record for dividend raises. Let's look at some reasons to prefer its main competitor, Lowe's (NYSE: LOW), if you're seeking a balance between growth and income in the home improvement retailing industry.

Price and value

There's a significant gap between the two companies when it comes to growth, and it's no surprise that the industry leader comes out ahead on this metric. Home Depot's comparable-store sales are on track to decline by between 3% and 4% in fiscal 2023, management confirmed in their recent earnings update. Lowe's, meanwhile, reduced its outlook and is now expecting a 5% comps drop on the year.

That performance gap can be explained by the fact that Home Depot has a larger sales footprint in the professional contractor segment, which is growing today. Lowe's, in contrast, gets about 75% of sales from do-it-yourself customers who are pulling back on spending these days.

Yet, that industry niche will recover, just as it has after all previous cyclical downturns. In the meantime, Lowe's is boosting sales in its professional segment, laying the groundwork for faster growth ahead.

Profit opportunities

Lowe's isn't as profitable as its larger rival, but income investors might still expect steadily rising dividend payments ahead. Its payout is easily covered by earnings, accounting for just 33% of profits over the past nine months. Home Depot's payout ratio is much higher, at 55% of earnings, leaving less room for quick hikes through downturns. The retailer is projecting a 10% profit decline for the 2023 year, after all.

Lowe's also has a good chance of closing its profitability gap with its main rival in 2024 and beyond. Home Depot converts about 15% of sales to operating profit each year, and for many years, Lowe's was significantly below that level. That trend seems to be shifting, partly thanks to Lowe's efforts at boosting efficiency. If the retailer can make a meaningful push toward 15% profit margins, the stock is likely to outperform the market from here.

The cheaper option

Income investors will love the fact that Lowe's has been able to pay -- and boost -- its dividend for over 25 straight years. Home Depot had to pause its annual hikes during the worst of the Great Recession, on the other hand. Another pause is a bit more of a risk for Home Depot going forward, given its higher payout ratio and its projected earnings decline this year. Cash flow can easily fund a boost for 2024, yet risk-averse investors might still prefer Lowe's as a safer income option here.

The stock is also cheaper on both a price-to-earnings and a price-to-sales basis. You can own Lowe's for 1.4 times revenue today compared to Home Depot's P/S ratio of 2.3. The industry's No. 2 player is priced at 16 times earnings compared to Home Depot's 23 times earnings.

Income investors should consider that discount a compelling one, especially since both stocks yield about the same rate at just over 2%. Home Depot has the stronger growth and profit metrics, yet Lowe's dividend is better protected and likely to support excellent returns for patient investors.

Should you invest $1,000 in Lowe's Companies right now?

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Demitri Kalogeropoulos has positions in Home Depot. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe's Companies. 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.


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