Set Up a Pairs Trade With Lowe's and Home Depot

Judging by the response to the Home Depot (HD Quote) third-quarter earnings report Tuesday, with investors pushing the stock down 12.5% to $25, you would think the company's management has no idea how to operate a retail business.

At least not like Lowe's (LOW Quote), which has only lost 11.9% year to date compared with a 50.8% drop for Home Depot. The three-year returns, in which Home Depot shares have fallen 53% while Lowe's has gained 52%, hammer home the diverging paths along which investors have sent these two rival home-improvement retailers.

Granted, Lowe's is benefiting from being the smaller of two, with about 800 stores in 42 states, versus Home Depot's 1,400-store national coverage. Lowe's can still satisfy Wall Street's desire for growth by expanding into fresh territories, but once the expansion inevitably tapers off, will the growth rate be that different? Is Home Depot really about to become K-Mart to Lowe's Wal-Mart? I don't think so. And how can you play this divergence? Pair them up.

What It Means

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