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Sunday, February 5, 2023

Lowe’s Stock Is Running into Valuation Friction

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Lowe’s (NYSE:LOW) stock failed to rally in a meaningful way after the home improvement retailer reported blowout second quarter numbers in mid-August that were broadly the best numbers the company has ever reported.

Source: Helen89 / Shutterstock.com

Sound familiar? It should.

A day earlier, Home Depot (NYSE:HD) also failed to rally after that home improvement retailer reported equally amazing numbers that were basically the best numbers that company has ever reported.

Why are these home improvement stocks failing to rally on record-breaking numbers?

Valuation friction.

Much like HD stock, LOW stock is overvalued and overbought at current levels. Investors would be wise not to chase to this rally, and instead wait for a better entry point into a stock that has simply become too hot.

Here’s a deeper look.

Strong Lowe’s Earnings

As was expected, Lowe’s reported record-breaking second quarter numbers that broadly underscored that, indeed, consumers are shifting spend towards home improvement projects and household appliances amid the Covid-19 pandemic.

The numbers themselves were jaw-dropping.

U.S. comparable sales rose 35.1% in the quarter, paced by a 23% rise in transactions and a 12% jump in average ticket. All 15 merchandising departments generated comp sales growth over of 20%. All 15 U.S. regions delivered comp sales growth of at least 30%.

Total sales rose 30.1%. Digital sales rose 135%. Gross margins expanded by 197 basis points. Operating margins expanded by 315 basis points. Adjusted earnings per share rose 74%.

The momentum isn’t slowing much. July comps rose 28% and August comps are trending right below that.

All in all, it was simply a superb, record-breaking quarter for Lowe’s. But LOW stock failed to rally on this super strong result, and that’s a fed flag.

The Party Won’t Last Forever

This record-breaking party over at Lowe’s won’t last forever, simply because the pandemic won’t last forever, either.

Over the next few quarters, consumer economic and social behavior will increasingly normalize, both because of increased consumer comfort with the virus, and elevated preventive measures at restaurants and other public settings. Potentially boosting this normalization in a big way will be a widely available vaccine in 2021.

As consumer behavior does normalize, consumers will start going out again. They’ll stop spending all this time in their homes. Spending allocation will normalize, with home improvement projects earning a smaller share-of-wallet in 2021 than in 2020.

That’s not to say that Lowe’s and other home improvement retailers won’t sustain healthy growth in 2021 and after. They will. But it won’t be 30%-plus sales growth. It will be more like 2% to 5% sales growth.

The unfortunate reality about LOW stock is that it simply is not priced for this coming slowdown.

Overvalued and Overbought

Across the board, LOW stock is trading at a premium valuation relative to its historical normal. Just look at the current valuation multiples:

  • 23x forward earnings, a near 30% premium to the stock’s five-year-average 18x forward earnings multiple.
  • 1.6x trailing sales, a near 50% premium to the stock’s five-year-average 1.5x trailing sales multiple.
  • 18.4x trailing cash flow, a 20%-plus premium to the stock’s five-year-average 15x trailing cash flow multiple.
  • 16.5x trailing EBITDA, a 25%-plus premium to the stock’s five-year-average 13x trailing EBITDA multiple.

Sure, some of this valuation premium is warranted because of the huge 2020 surge in sales and profits. But not all of it, especially since this surge won’t last forever, or even much longer than another few months.

My numbers, which broadly assume that Lowe’s returns to a pre-Covid growth trajectory in 2021 and sustains that normal growth trajectory into 2025, put 2025 earnings per share for Lowe’s at $10.50.

Based on a 20x forward earnings multiple, which is historically average for the home improvement retail sector, that implies a 2024 price target for LOW stock of $210.

Discounted back by 8.5% per year, that implies a 2020 price target for Lowe’s stock of about $150.

Thus, LOW stock is trading above fair value today.

Not to mention, the stock is overbought. The Relative Strength Index (RSI) is around 75 today, solidly into overbought territory (above 70). Previous RSI readings this high usually coincide with a near-term peak in the stock.

Bottom Line on LOW Stock

Lowe’s is a great company. But the stock is overvalued and overbought today, ahead of what will be a significant slowdown in the company’s growth trajectory over the next few quarters.

So, don’t chase this rally in LOW stock. Let the slowdown happen. Let it create weakness in the stock. Then buy the dip.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not own a position in any of the aforementioned securities.

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