Lowe’s Stock: Are You Smarter Than a 7th Grader? (NYSE:LOW)

Back in 1990, seventh graders at St. Agnes School in Arlington, Massachusetts were asked to put together a model portfolio of stocks.The goal was to see if they could beat the brightest minds on Wall Street. I had to choose a company with a product that could be easily explained to the class. Naturally, they chose companies like Disney (DIS),Nike(NKE), Walmart (WMT), McDonald’s (MCD) very conspicuous (think moat) and easy to understand (simplicity is key).

To the surprise (or less) of observers, their stock portfolio produced a 70% return over the next two years, well above the 26% return of the S&P 500 (SPY) over the same timeframe. . Even more impressive, the student’s portfolio topped his 99% of all equity mutual funds managed by Wall Street professionals during the same period.

This is one such recognizable company, Lowe’s (New York Stock Exchange: Low), which fits the characteristics of the strain chosen by the 7th graders at St. Agnes’ School. This article highlights why the low price of this fantastic stock can yield such strong returns for value investors. Let’s get started.

why low?

Lowe’s is the second largest home improvement retailer in the world, behind The Home Depot (HD), with approximately 2,000 stores in North America (US and Canada). Retail do-it-yourself customers make up the majority of sales (75%), but they also do a fair amount of business with commercial and professional customers, who account for the remaining quarters of sales.

Lowe’s stands out for its sheer size of store footprint and strong consumer empathy. This provided economies of scale. This is especially important for competitive retailers. Additionally, unlike growing companies that have to pay large annual growth capital expenditures just to “feed the beast,” Lowe’s already mature footprint allows it to deliver more capital returns to shareholders. .

This is reflected in the company’s aggressive share buybacks. As you can see below, Lowe’s has retired an impressive 43.5% of his outstanding shares over the past decade.

For those familiar with how balance sheets work, companies that aggressively buy back their own shares end up with negative equity. This simply means that the stock returned more value to shareholders than the original stock. As you can see below, this impressive feat was accomplished during Lowe’s last fiscal year.

It goes without saying that Lowe’s business is tied to the overall health of the housing market. Lowe’s business is also under pressure as rising interest rates and inflation strain home renovation budgets. This was reflected in a 0.3% decline in same-store sales in the second quarter. However, while DIY sales (which make up Lowe’s 75% of his business) were under pressure, the segment appears to be gaining Pro customers as the segment showed his 13% growth year-over-year. is.

Encouragingly, Lowe’s didn’t have to sacrifice big margins, gross margin was 33.2%, 54 basis points lower than last year. As you can see below, Lowe’s remains profitable relative to the sector, with an EBITDA margin of 15% and a net profit margin of 8.8%, ahead of the overall retail industry of 11.3% and 5.6% respectively.

Looking ahead, we expect the DIY segment to continue to come under pressure as persistently high inflation continues to drive up interest rates and put pressure on household budgets. That said, I believe the long-term proposition is intact, and management continues to evolve the business, as reflected in the recent announcement of same-day delivery by Instacart (ICART). As management pointed out at last month’s Goldman Sachs (GS) Global Retailing Conference, there is still a lot of untapped room in the home improvement market.

As we look to the next few years, Lowe’s is focused on growing both professional and DIY by continuing to execute our total home strategy to deliver continued top-line and productivity. increase. For reference, home renovation is a $900 billion market in the US. Combined with Lowe’s and its largest competitor, it represents a market of approximately $250 billion. Therefore, we believe there is great opportunity for continued growth in both Pro and DIY as a result of this fragmented environment.

Meanwhile, Lowe’s maintains a strong balance sheet with a BBB+ rating, and the more conservative bond markets seem to allow Lowe’s to survive for years to come.

And don’t forget that Lowe’s is a dividend king with 59 consecutive years of dividend increases. The 2.3% dividend yield isn’t particularly high, but his CAGR over 5 years is quite high at 19.5%, well protected by a 27% payout rate.

Finally, Lowe’s is attractively valued at its current price of $184, with a futures P/E of just 13.6, well below its typical P/E of 20.8 over the past decade. Analysts estimate annual EPS growth of 7% to 14% over the next two years and have a consensus buy rating with an average price target of $243. Lowe’s has the potential for double-digit annual returns just by returning to its average valuation.

Tips for investors

All things considered, I think Lowe’s is an attractive long-term investment at its current price. The company has a strong balance sheet, impressive margins and a long runway to growth. While short-term headwinds from rising interest rates and inflation weigh on same-store sales, Lowe’s is making the necessary adjustments by growing his Pro business and expanding same-day delivery capabilities.

I believe the market is underestimating Lowe’s long-term prospects, and the stock could rise significantly from its current levels. Finally, Lowe’s fits the mold of a quality company that his 7th grader understands and now trades for cheap.