Over the past 15 years, Lowe's has consistently demonstrated an ability to generate wealth for its stockholders. It increased equity from about $1 per split-adjusted share in 1994, to $13.30 in 2010, and paid out a total of $1.70 in dividends per share (that's an 18% compound annual growth rate):
This growth in equity per share has translated into a share price increase from $3 in 1994 to around $21 today, plus dividends - a compound annual growth rate of about 14%. LOW significantly outperformed the S&P 500 index, which grew at 8% from 1994 to the beginning of this year.
The source of this wealth is a business generating returns on equity (ROE) with a median value of 16% per year, well above the cost of capital:
Furthermore, the ROE is of good quality, because the company does not use significant leverage, as evidenced by a consistently high return on total assets (ROA) - see also the debt-to-equity ratio below.
This kind of a consistent above-average ROE is a strong indicator of a sustainable competitive advantage, a "moat" around Lowe's business, to use the terminology of Warren Buffett (who is an investor in the company). In the aftermath of the housing bubble, ROE has dropped to 10% - average by S&P 500 standards. A key question in making an investment decision is whether the ROE can recover to its historic levels. We think so, based on the following considerations:
- the strategic competitive position of the company - a duopoly with Home Depot (HD) - has not changed,
- the home improvement retail market has not been structurally altered, and
- Lowe's had a good ROE even before the housing bubble (prior to 2002).
What gives us further confidence in LOW is the fact that the company has a safe balance sheet with a low debt-to-equity ratio of 0.3, and no goodwill or intangible assets to speak of. The company can withstand a prolonged downturn with little risk to its financial health:
LOW is trading at P/E ratios of around 20. So, why do we think that Lowe's is attractively priced? For one, current earnings are depressed by the state of the housing market, and do not reflect the long term potential of the firm. Another reason is that LOW is trading at the price to book ratio of 2, which is close to the lowest it has been in 15 years:
While P/B of 2 is not a bargain in the Graham sense of value investing, it is a low price for a company in great financial condition, and earning solid returns on equity. After all, if the company restores its long-term ROE, it will double its shareholders wealth in less than 5 years, and the price will follow.
Couple that with smart capital allocation decisions by the company - with its stock price depressed, Lowe's has been buying back its shares since 2006:
...and you got a stock that will reward patient long-term investors.
The charts used in this article come from StockPup.com. Today, StockPup opened a preview beta version of the site to the public. StockPup provides fundamental stock analysis tools to individual investors who follow the long-term investing philosophies of Warren Buffet, Benjamin Graham, and David Dodd. Registration is free, and you can use StockPup charts in your own blog or articles, or simply use the research to gain deeper understanding of stocks you invest in.
Disclosure: long on LOW