Who's Winning the Home Improvement War?

Who’s really winning—Lowe’s or Home Depot? In this video, Steve breaks down the financials behind these two retail giants to see who comes out on top.

You’ll get a side-by-side look at revenue, profit margins, and return on invested capital (ROIC)—plus why ROIC is one of the most important (but often overlooked) metrics in business. Steve also reveals what the income statement doesn’t tell you and how to dig deeper into a company’s true performance.

Whether you're an investor or just love smart business analysis, this one’s full of insights you won’t want to miss.

TRANSCRIPT:

Who do you think is more profitable, Lowe's or Home Depot? Both compete in the home improvement arena, but their financial results are definitely different. And I'm going to walk you through the financial analysis of both companies, starting with Lowe's, and then I'm going to get into Home Depot. And then at the end, I will tie everything together as we evaluate their revenue, their profitability, their return on invested capital, their free cash flow, and their growth.

I know a lot of nerdy things, but trust me, you're going to want to stick around until the end, because that's when the magic comes alive. And I show you how to evaluate a business and what they're actually worth. Now, let's start with Lowe's because when I got started with working, I actually had a job at Lowe's.

They're called Eagle Hardware at the time, but then they got bought up by Lowe's. And I also had a job at Home Depot. So I've worked at both of these companies, not to brag, I know, kind of a big deal here.

I worked in the plumbing department, selling plumbing parts and toilets. I know, kind of cool. But anyways, let's walk through both of these companies.

The ticker symbol for Lowe's is LOW. The ticker symbol for Home Depot is HD. I pulled the financial statements on a trillion 12-month basis, as of the recording of this video, July of 2024.

And we're going to be looking at these numbers in billions of US dollars. All right, let's go ahead and jump in. The first line item that we want to evaluate in our analysis is revenue.

This represents the amount of income that the company generates from selling its products and services. So if you've never been into a Lowe's or Home Depot, they sell gardening supplies and electrical supplies and plumbing supplies and all sorts of things in order for people to maintain their homes and to remodel them and to make improvements along the way. All right, so this line item represents the sales of all their products and services.

Lowe's sells $85.4 billion a year across all its stores. We're going to walk through Lowe's, and then I'm going to walk through Home Depot, and then we're going to do the analysis, and I'm going to show you what this all means, the story behind the numbers. Pretty cool, right? All right, so we take revenue and we subtract costs of goods sold.

Costs of goods sold is going to represent the direct labor and the material cost and all other costs associated with delivering the products and services into the hands of customers. So when you take revenue and you net out costs of goods sold, you end up with gross margin, also known as gross profit. $28.4 billion in gross margin.

Now, when I'm evaluating a company, I like to express these line items as a percentage of revenue. So I will take gross margin as a percentage of revenue. So I'll just take $28.4 divided by $85.4, and I love this number here because three is my lucky number.

And check that out. Their gross margin is 33.3. Serendipitous, right? Okay. If you're following along, you could do this in a spreadsheet.

You can have an Excel spreadsheet opened up while you're watching this video, or you could also do it like I'm doing it, writing it down on a piece of paper and using your handy dandy calculator. I didn't want to bore you by doing like a Zoom style YouTube here with my head in the corner where I'm just talking at you through a spreadsheet. All right.

That's not super helpful. You get me in the flesh, face-to-face on a whiteboard. All right.

So we have gross margin, 33.3%. Moving down the line, we have EBITDA, earnings before interest, taxes, depreciation, and amortization. This is just one nerdy way of saying profit, right? So you are ignoring interest, which is part of the capital structure, and you are not considering depreciation and amortization associated with their capital expenditures. All right.

So EBITDA gives you an apples-to-apples comparison with companies because you're ignoring the capital structure, which is different for every business because every business has a different level of debt and equity, and you're ignoring depreciation and amortization and how the company decides to invest in property, equipment, and then depreciate those assets. All right. So EBITDA for Lowe's is $13.0 billion.

As a percentage of revenue, it's 15.2%. All right. I'm going to get all the numbers up here on the board, and then we're going to talk about it. All right.

But I want to walk you through line by line so you not only know how to do this for a publicly traded company, but you know how to do this in your business. So if you're making financial decisions on behalf of your company, this is a great analysis to do. And if you're an aspiring financial professional, you're a student and you want to get into the world of business, knowing how to do this is going to give you a huge competitive advantage compared to your peers.

All right. So EBITDA is just one form and variation of profit. If we look at operating income though, operating income represents the amount of profit a company earns after taking gross margins, subtracting out operating expenses, and it's the profit that they're earning on normal operations.

So the normal operations of the business. And for Lowe's here, they earn $10.9 billion. But we have to account for tax.

We're not there yet. And tax is very nuanced for companies because there may be deferred taxes that they have to account for. There may be credits, there may be losses from the past.

So there's all sorts of things. So what I did just to keep things apples to apples, I just applied a 21% corporate tax rate to operating income to get to net operating profit after tax, which gives us $8.6 billion. NOPAT as a percentage of revenue is 10.1%. Now, if you've watched my other videos or you listen to my podcast, or you're in one of my programs, Financial Fundamentals or Financial Pro, you will know that the average profitability for industries across the board is around 10%.

So that's just a good number to go off of. So when you do this for your company, if you're below the 10% mark, either you're in a super competitive industry and profits are less than this, or you're just underperforming. I know, kind of sad.

But there's hope because when you know the numbers, you can understand what are the drivers to improve those numbers. All right. That's the income statement, but the income statement only gives us a fraction of the story.

In fact, the most important story comes right down below. That's what we're going to get into right now. All right.

If we go to the balance sheet and we look at invested capital, and this is computed by taking the net property plant and equipment balance plus working capital. So we just take net PP&E plus working capital. And we combine these together for Lowe's, they have $20.9 billion tied up in invested capital.

In other words, this is the amount of capital they've had to invest in the business in order to have a business to generate these returns. All right. So that's how invested capital works.

The lower the number sometimes is better, especially when you can lower this number, but still have high returns up above because it will accelerate this next metric, which I love to compute for companies. And that's return on invested capital. That's computed by taking net operating profit after tax and dividing that by invested capital.

And for Lowe's, it's 41.2%. Not bad. Not too shabby. Think about the S&P 500 over the last 50 years or so, it's returned on average between nine and 11%, whatever.

And so for Lowe's, they are exceeding those returns right here by 4X. So not too shabby of a business. I also like to look at free cashflow.

So if you go to the statement of cash flows and you take cash from operating activities and you deduct CapEx, then you end up with $8.3 billion of free cash. This represents the amount of cash available to pay down debt, to return to equity providers, or to reinvest in the business. This also is the driver of intrinsic value because intrinsic value is computed by taking the present value of all the future cash that the business is expected to generate.

So that's why I love free cashflow. I am a lover of this. Here's my heart.

Okay, there we go. Free cashflow, let's just do that as a percentage of revenue, and that's 9.8%. And this is really important to understand because this spread between net operating profit after tax and free cashflow is pretty close for Lowe's, in fact. But for a lot of businesses that I work with, the profit number is actually a lot higher than free cashflow.

And this is where 70% of companies that go bankrupt are actually profitable when they close their doors because they have profit, but they don't have the cash. And you could definitely go out of business if you don't have cash in order to cover your bills. Profit doesn't cover your bills because there's networking capital and CapEx that is not accounted for in profit up above, but it is accounted for down below in free cashflow.

That's why I like free cashflow. All right, let's keep going. We're almost there.

Next, we have the price to earnings multiple. And this just tells us how much an investor is willing to pay based on the current stock price for every $1 of earnings. And for Lowe's, it's 19.3X. So in other words, they're of earnings.

And that's based on the stock price today. So just keep that in mind. This is always changing based on what the market is valuing the stock price at.

Two more. And we're going to move over to Home Depot. We have growth over the next five years.

So looking five years ahead. And we have growth over the last five years. Two important things to look at.

Over the next five years, Lowe's is expected to grow a meager 4%. Think about GDP growth in the United States. It's around 2%, 3% maybe.

So for Lowe's, they're expected to grow just slightly above the national GDP rate. So not super fast growth, especially when you compare the last five years, they've grown at 21.7%.

All right. Let's take a deep breath here.

I just did a lot of talking. I drew a lot of numbers up here on the board. But this is really helpful because you're going to see how I tie this all together.

Now, I'm going to go a lot faster on the Home Depot side because I explain each of these line items and I think you understand them now. So let's just put the numbers up on the board for Home Depot. And then you're going to stick around because when I do the evaluation in this analysis at the end, you're going to be like, oh, I see.

And you're going to have some really good talking points with your friends, right? Especially if you want to be nerdy. Okay.

So Home Depot, check this out. Home Depot does almost double the amount of sales compared to Lowe's, $151.8 billion. So they have a lot more scale compared to Lowe's. So many more stores.

Gross margin, 50.8%. And check this out, 33.4%. So almost my lucky number, except for the last digit screwed it up. But they're pretty much neck to neck as it relates to their gross margin. So that's great.

Then when it comes to EBITDA, $24.7 billion in EBITDA, which is 16.3%. Now remember between gross margin and EBITDA is operating expenses. This is the cost structure of the business. So Home Depot is running at a more efficient cost structure.

So OPEX, remember, includes things such as general administrative payroll, professional fees, sales and marketing costs, occupancy costs, and so on and so forth. So that's why they're able to pick up an additional spread here, additional percentage point as it relates to Lowe's.

Now with their operating income, Home Depot produces $21.2 billion. Net operating profit after tax is 16.8, which is 11%. So with their cost structure, they're one percentage point higher compared to Lowe's from a net operating profit after tax standpoint.

Let's look at their invested capital. Home Depot has $45.2 billion invested in property plant equipment. That's net and their working capital, which gives them a return on invested capital of 37.2%.

I'm going to come back to this, but just note here, it requires more invested capital to run Home Depot's compared to Lowe's.

Free cash flow is 17.9 billion, which is 11.8% of their revenue.

Their PE ratio is 24.1X. Their growth rate over the next three years is actually lower than Lowe's. Lower than Lowe's, that sounds kind of funny, but it's 3.4% compared to the last five years, 10.3%.

All right, there you have it. All the numbers are up on the board.

Now let's go through the numbers and understand the story behind what they're representing here. So first we talked about this. Okay.

Revenue, Home Depot has Lowe's beat. Ding, ding, ding. They're the winner.

They could say, oh, we're so much better than you. We're so much bigger. And a lot of companies, they'll brag about revenue, but revenue, it's important, but it's not the winner at the end of the day.

The next line item that I like to look at is gross margin, but they're pretty consistent right here. What's interesting though, is from a strategy standpoint, Home Depot seems to be pursuing a cost leadership strategy.

They're trying to price their products competitively and be the cost leader in the marketplace. And that's how they're competing versus Lowe's, which is trying to compete with them, obviously on cost, because there's cost sensitivity. But if you've ever been to a Lowe's store, it's definitely different in format, layout, design, everything else compared to Home Depot. They're trying to differentiate themselves.

But I think Lowe's is stuck between this cost leadership strategy and differentiation. So there's a little bit of straddling going on, which isn't terrible. It's not like they're underperforming the market drastically compared to Home Depot, but it's just something to be aware of.

And somebody who's a strategist like me, who's nerdy like that, I always like to look at their strategy as it relates to their finances.

Then, like I said, they're picking up one percentage point, Home Depot that is, from their cost structure. They have a lower cost structure, probably because they can leverage their economies of scale right here.

They have more scale, therefore they can operate maybe with a more efficient headcount. So they beat them right here on net operating profit after tax.

But then when we get down to invested capital, this is where a lot of companies get it wrong.

In my programs, I have two programs at byfiq.com. So if you want to take your skills to the next level and you're like, okay, I want to learn the mechanics behind all this because I want better financial skills. Well, guess what?

In these programs, I walk you through what this means in more detail. And this is so critical because when I'm consulting businesses, I'll say, look, what is your return on invested capital?

Yes, this is important up here, but then there is this number down below that's tied up in invested capital in your business.

And if you're not generating sufficient returns on that money, then you may be ignoring other costs.

Because look at this, Home Depot has to invest $45 billion in its stores and everything else in order to generate the returns of above, which has a drag on the return on invested capital. So it's about 4% lower compared to Lowe's.

Not too shabby. These returns are still really good, especially when you compare it to other industries out there that generate around 10 to 12% returns. But still there is a difference behind the scenes.

So when I'm working with companies, I show them this and sometimes they'll be profitable up above, but they have so much capital invested in the business or tied up in property plan equipment or working capital that they may only be generating like a 4% return on their invested capital.

So do this in your company, do this calculation or do this calculation with other publicly traded companies so you can see what I'm talking about here. And what you'll find is really staggering.

And this ties back to strategy. So if a company doesn't have a good strategy, then this right here is often a lot lower.

Going back to that example of a company with 4% return on invested capital, think about it. You could put your money in a money market account right now and earn like what? 4.25, 4.5%. Very, very low risk.

So if your return on invested capital is low because you're investing in your business and scaling, okay, that's fine. But if you're a mature business, you have to figure out how can you leverage your capital to earn higher returns.

And Lowe's has Home Depot beat in this area. So just something important to point out.

When it comes to free cashflow though, Home Depot is managing its free cashflow, at least from a percentage of revenue standpoint, much better than compared to Lowe's.

And since free cashflow drives intrinsic value of the business, this is really important to pay attention to.

And then when we look at growth over the next five years, Lowe's is slightly above Home Depot at 4% compared to 3.4%. So they have them beat right there on estimates.

But if you also look here, Lowe's was growing at 21% and now they're slowing down to 4% compared to Home Depot is growing at 10% and now they're slowing down to 3.4%, right? So it's not such a drastic drop in the growth rate here.

But I think when you combine return on invested capital and free cashflow and the growth rate together, that's why investors may be willing to pay more for Home Depot stock because right now it's trading at 24.1X price to earnings compared to 19.3X as it relates to Lowe's.

So kind of cool, right? You can look at the numbers, you can understand the story behind the numbers.

And when you can understand how to do this analysis, and then more importantly, how to go execute in your business, you will drive a tremendous amount of value.

Because here you can say, look, I understand the three drivers. It's price premiums, it's cost and capital efficiencies, and it's volume.

Or you may say, yeah, I know how to improve invested capital because you know where to look on the financial statements.

And you can say, yeah, we can make improvements with our CapEx by doing this and this and that, which will accelerate growth up above, which then has an impact on our return on invested capital and free cashflow, which drives our value.

And when you can talk nerdy like that, see, you can drive a lot of value in business.

All right, that's all I have for you. This has been really fun.

But now you know, hey, look, Home Depot right here has a lot more scale than Lowe's.

And I just, I like knowing these numbers. I'm just nerdy like that because when I go into Home Depot, I'm like, yep, they're earning a 33% margin on the products and services overall. And I know how much they're earning in profit.

It's just really fascinating to me.

So when we open up our eyes to the world around us, and when we start evaluating businesses, and I do this with pretty much every business I go into, I'll walk into a flower shop and I'm like, I wonder what their rent is. I wonder what their average transaction value is. What's the return on invested capital?

Then I'm always curious about this because when you understand business in this way, so many opportunities open up.

All right, thanks for joining me. Be sure to share so we can spread the word out there and educate more people across the world.

Thanks for joining me. Until next time, take care of yourself. Cheers.