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Time to Build a Position in Home Improvement Stocks?

The Home Depot (NYSE: HD) reaffirmed its fiscal 2019 earnings outlook last November, even though full-year revenue and comparable-sales growth of 1.8% and 3.5%, respectively, were lower than previous guidance management offered. Shares have only recently recovered to pre-announcement levels, but I have a hunch that the company and industry overall are in a strong position in 2020 and beyond.

Here's why now is the time to nail down (pun intended) a position in the home improvement sector.

Image source: Getty Images

Big picture trends lay a good foundation

In a 2015 report, the United States Census Bureau said, "Between 2014 and 2060, the U.S. population is projected to increase from 319 million to 417 million, reaching 400 million in 2051." Based on those projections, demand for items such as lumber, electrical and plumbing supplies, and all of the other materials that typically go into housing and construction will enjoy strong demand.

Another item that draws my attention is a report from the Joint Center for Housing Studies of Harvard University entitled "Improving America's Housing 2019." It shows a pretty healthy progression of the home remodeling market from $277 billion in 2010 to $424 billion in 2017. This same report also indicated that "with new construction still slow to recover from historic lows, almost 80% of the nation's 137 million homes are now at least 20 years old and 40% are at least 50 years old."

There is no guarantee these trends will become tailwinds for the home improvement industry, but management at companies like Home Depot and Lowe's (NYSE: LOW) are no doubt excited about the potential for their businesses.

So which companies deserve a look?

Of the two major home improvement stocks mentioned so far, I tend to favor Lowe's. Though revenue in the third quarter was roughly flat compared to the prior-year period at $17.4 billion, comparable sales saw a 2.2% gain. For the first three quarters of 2019, earnings were up 25% year over year to $4.80 per share. Looking ahead, the company is expected to continue growing at a healthy pace with double-digit earnings growth for full-year 2019, 2020, and 2021 -- not bad for a brick-and-mortar retail chain.

The fact that Lowe's has been consistently returning capital to shareholders shouldn't be overlooked either. Per its third quarter earnings release, "[...] the company repurchased $835 million of stock under its share repurchase program and paid $428 million in dividends in the third quarter." The stock yields 1.8% as of this writing.

So what about Home Depot? The company has earned its title as the leader of this space with a storied operating history and deep product selection. It has also excelled serving its "Pro" market -- industry professionals who have become some of Home Depot's biggest and fastest-growing customers.

But analysts do not expect Home Depot to see earnings grow at quite the same pace as its rival, and though it also sports a healthy 2.4% dividend, valuation is the sticking point. Home Depot trades at 21.5 times forward earnings estimates, while Lowe's has a lower multiples of 18.5 times and a stronger growth trajectory over the next several years.

A third name to consider

Sherwin-Williams (NYSE: SHW) is another name I'm keeping an eye on as a big fan of its paints and in-store customer service, not to mention its ability to thrive despite stiff competition from the industry heavyweights covered above.

The company has healthy solid cash generation, which has similarly given it the flexibility to reward shareholders. In fact, CEO John Morikis highlighted during the most recent earnings call, "Year to date, we returned over $892 million to shareholders through cash dividends and share repurchases, an increase of 46% year-over-year."

On a pullback, I think Sherwin-Williams could really be interesting. With analysts forecasting several more years of double-digit earnings growth and a 0.8% dividend yield, the main thing holding me back is price. The stock commands the richest valuation of the three companies with a forward price-to-earnings multiple over 25 times.

Regardless of who you pick from this home improvement trio, I'm left with the feeling that each company is well-positioned to take advantage of the long-term benefits of a growing population and aging housing market across the country. Any pullback among these stocks would only sweeten the situation.

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Glenn Curtis has no position in any of the stocks mentioned. The Motley Fool recommends Home Depot, Lowe's, and Sherwin-Williams and recommends the following options: long January 2021 $120 calls on Home Depot and short February 2020 $205 calls on Home Depot. The Motley Fool has a disclosure policy.


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