Focus on Home Depot as a Value Play

For the first quarter of this year, Home Depot's earnings rose 19%, beating Wall Street's EPS estimate by 3 cents. Home Depot's shares, however, dropped on the day it reported results, because sales fell a bit short of expectations.

The company also halted its practice of reporting quarterly same-store sales. The move means it's difficult to make comparisons to Home Depot's chief competitor, Lowe's (LOW Quote), which reported a 5.7% jump in same-store sales for the quarter. Credit Suisse First Boston analyst Gary Balter estimates that Home Depot's same-store sales rose about 1%.

While Home Depot faces saturation in North America with its 2,065 retail stores, Lowe's has only 1,250 stores. Its growth prospects appeal to investors, who have bid up the stock 173% over the past five years, and its stronger comps suggest it may be advancing on its rival in terms of market share.

At around $63, Lowe's trades at more than 15 times Wall Street's earnings estimates for the company for 2006. By the same measure, Home Depot trades at $38, around 12 times estimates. Meanwhile, fears about the effects of rising interest rates on consumer spending and the slowing housing market are weighing down the valuations of both companies. But even though the economy is facing a slowdown, Home Depot shares look particularly cheap considering its long-term prospects.

"Home Depot is no longer a growth stock," says Chukumba. "It's a value stock, and investors are slow to make the shift in the way they view it. The same thing is going on at companies like Microsoft (MSFT Quote) and Wal-Mart (WMT Quote). Growth is slowing, but the returns on capital are still excellent. The market has yet to appreciate this."

Based on Morningstar's valuation, using a discounted cash-flow method, Chukumba puts Home Depot's fair value at $44, a 16% premium to today's price. Meanwhile, Matrix USA rates it a strong buy based on its high returns, low price and low risk profile.