Lowe’s stock trades at fair valuation
The current situation surrounding Lowe’s (NYSE:LOW) stock reminds me of the wisdom of Warren Buffett: you’d rather buy a wonderful business at a fair price than a fair business at a wonderful price. Indeed, LOW’s valuation is by no means cheap as seen in the chart below. This chart displays LOW stock’s valuation grade in comparison to the sector median and its own 5-year average levels. As seen, LOW stock has an overall valuation grade of quite an off-putting D-. Overall, LOW’s P/E ratios are higher than the sector median by a large margin and quite close to its 5-year average levels. For example, its P/E ratio (TTM) stands at 17.46x, not cheap at all in any absolute or relative terms. It is higher than the sector median of 13.82x by 26.28% and essentially on par with its 5-year average of 18.55x.
In the remainder of this article, I will argue why LOW still presents a compelling BUY thesis despite such valuation grades once its profitability and growth potential are considered.
Lowe’s stock: robust profitability and growth potential
The chart below summarizes LOW stock’s profitability grade, and the picture I see is the polar opposite of the valuation grades. As seen, LOW’s overall profitability grade is A+. Gross profit margin is the only area where LOW lags behind the sector median (and only by a small amount of ~3%). By all other metrics, LOW’s boasts superb profitability measures. For example, in terms of EBIT margin, LOW’s current EBIT Margin (on a TTM basis) hovers around 13.38%, which is significantly higher than the sector median of 7.64% by more than 75%. EBITDA Margin and Net Income Margin paint the same picture.
Thanks to its strong profitability, I see an upbeat outlook for its profit growth and shareholder return ahead. The following chart shows consensus EPS estimates for LOW stock in the next 4 years. As seen, analysts expect Lowe’s EPS to suffer a short-term decline in the near term – for good reasons, and I will revisit this point later in the risk section. But after that, a strong recovery is expected followed by sustained growth with double-digit rates. To wit, analyst consensus estimates its EPS to reach $13.50 in FY 2026 and $14.94 in FY 2027. These numbers translate into an annual growth rate of 10.75% and 10.65%, respectively. Also note that, with the projections, its implied FWD P/E would shrink quite quickly. The current FWD P/E is 18.7x, as just mentioned. It would go down to 16.8x in FY 2026 and only 15.2x in FY 2027.
I agree with the above optimistic growth curve for a few reasons. As frequent LOW customers (we have a Lowe’s store within walking distance of our house), we can appreciate several differentiators in its business model to keep loyal customers like us. Its focus on customer needs comes to the top of our minds. LOW prioritizes understanding customer project needs and recommending solutions. Trained associates act as consultants, offering guidance and product selection based on the project, which is super helpful, especially for amateurs like us. Besides amateurs like us, LOW also caters to a wider customer base, including DIYers (do-it-yourselfers) and professionals. This broader focus expands its market reach compared to competitors who might lean more towards professionals.
In the longer term, I am also optimistic about the home improvement sector. I expected a secular tailwind in this space. I especially expected a strong demand from DIYers in the years to come, as the recent pandemic has permanently and substantially shifted our work-life style. The prospects for a thawing residential resale market are another catalyst in my view. As I do not expect the current high borrowing rates to persist forever, I expect more homes to come back on the market for sale in the coming years. In this case, upgrades and repairs will be of paramount importance to both sellers and buyers.
Lowe’s dividends
I do not feel an article on LOW could be complete without a word about its dividends (BTW, it is a dividend champion). Thanks to its robust profitability and growth outlook mentioned above, I expect capital to continue to make its way to shareholders as dividend payouts (plus some share repurchases too). In terms of dividend yield, its current yield (shown by the solid red line in the chart below) is above its historical average in the past 10 years (shown by the gray dotted line). The gap is actually a substantial amount when measured against the 1 standard deviation level (shown by the orange line with symbols) as seen, serving as another indicator of its close-to-fair valuation even though its P/E is substantially above the sector median.
Downside risks and final thoughts
In terms of downside risks, LOW faces all the risks common to its home Improvement peers. These risks include the potential of an economic downturn, the potential of further interest rate hikes, competition intensification, etc. In particular to LOW stock, I won’t be surprised to see some negative impacts from an uneven economic backdrop and lingering inflation in the near future. I anticipate these headwinds to keep weighing on consumer spending, most notably in the do-it-yourself category, an important segment that LOW caters to as aforementioned. These are the key factors in my view that lead to the consensus expectation of an EPS decline in the next FY, as discussed above. Another risk that is more specific to LOW in my view involves its relatively large focus on appliances compared to building materials. While appliances can offer higher margins, they might also be more cyclical in demand compared to building supplies.
To reiterate, during uncertainties time like ours, it is especially important to invest in wonderful business even at fair prices. That is why I rate LOW as a BUY under its current conditions. Admittedly, I do not see a deeply discounted price here. However, I do not see an obvious overvaluation either in terms of P/E or dividend yield in comparison to its historical track record. Yet, the stock offers robust profitability and promising growth potential. Its history of consistent dividend payouts and share repurchases adds further downside protection. All told, there are very likely some speed bumps in the immediate future (as indicated by consensus expectation of an EPS decline in the next fiscal year), my verdict is that LOW presents a highly asymmetric return/risk profile for investors seeking mid- to long-term total returns.