Valuation of Different Companies

Valuing Common Equity

Comparison of Lowes and The Home Depot

There are different methods that firms and investors can use to value the common equity that a corporation holds. The different methods all have strengths and weaknesses in different circumstances and it is important to understand these factors in any evaluation. For example, the company's future income stream will ultimately determine the company's fundamental value; however these calculations are not always what determines a firm's market price. Although there are many factors that determine the market price, the company's net present value (NPV) of future revenue streams can be useful to both investors and internal executives relative to managerial accounting. A company's NPV can be used to compare different direct investment opportunities as well as calculating an average cost of capital to serve as an investment baseline; whereas indirect valuation are more subject and often lie on whether investors believe the stock is fairly priced. This analysis will compare two companies, Lowes and The Home Depot, in regards to the different valuation methods available.

Valuation Comparison

One of the most basic absolute valuation models is to look at a company's dividends (Investopedia, N.d.). Thus one method that can be used to compare these companies would be to compare the divided growth rate. Assuming the dividend growth rate is an accurate reflection of the company's earnings per share increases, comparing the actual dividends paid to investors allows for a direct comparison of the company's performance. A quick four-year comparison reveals that The Home Depot's dividend rate is growing slightly faster than Lowe's over the same period. However, both companies have strong dividend growth rates which is attributable to the companies both gaining in efficiency as well as benefiting from the recovery of the housing market (van Doom, 2015).

2015

2014

2013

2012

Lowes

0.28

0.23

0.18

0.16

% Growth

17.86%

21.74%

11.11%

HD

0.59

0.47

0.39

0.29

% Growth

20.34%

17.02%

25.64%

The dividends could also be used to determine an absolute values that one might expect to pay at any given interest rate. For example, Lowes dividend rate was twenty-eight cents per quarter or a dollar twelve annually. If an investor required a seven percent interest rate based on this dividend payment then the stock price would be estimated at roughly sixteen dollars. The same calculation for Home Depot would estimate the stock value to be at roughly thirty three dollars. However, the actual stock prices are around seventy-five and one hundred thirty one respectively. This clearly indicates that the market considers many more factors that just the dividend payments.

The most popular price multiples are earnings multiples and the price-to-earnings (P/E) ratio, which is equal to a company's market price per share divided by its earnings per share (EPS), is the most widely used earnings multiple (Ferris, K.; Petit, B., 2013). It provides an indication of how much investors are willing to pay for a company's earnings in the form of dividends as well as increased share prices or some combination of the two.

Figure 1 - P/E comparison (van Doom, 2015)

The Home Depot has been growing financially faster than Lowes in recent years and analysts have determined that the forward P/E ratio is slightly higher than that of Lowes. However, there are also many other considerations that come into play; for example, Home Depot showed stronger growth of comparable sales and overall earnings but also had a higher pre-tax earnings margin while Lowes boosted its sales and earnings per share faster than its competitor. Furthermore, despite these individual characteristics of each individual company's financial and operating performances, in general it can be said that both stock are relatively pricey which is undoubtedly driven by the expectation of solid growth in the housing industry. For example, the housing industry has grown at its fastest pace since the 2007 recession which represents a growth opportunity for both home improvement companies.