The Home Depot, Inc. (HD), And A Great Under-the-Radar Investment to Trade Considerably Higher

Restoration Hardware Holdings Inc (NYSE:RH) is a small retail company “similar” to that of The Home Depot, Inc. (NYSE:HD). The company focuses on a variety of merchandise assortments in various categories, including furniture, lighting, garden, décor, etc. For the year, Restoration Hardware has gained just 22%, much of which were gained on Friday after reporting earnings. However, this earnings report was an eye opener, one that could lead to much larger gains in the quarters ahead.

A Look at the Retail Home Improvement Valuation

Currently, The The Home Depot, Inc. (NYSE:HD) is the favorite when it comes to retailers in the home improvement space. It is twice the size of competitor Lowe’s Companies, Inc. (NYSE:LOW) and has returned twice the gains with a near 45% return in the last year. The Home Depot is a massive company, one with 340,000 employees and more than 2,200 stores. However, The Home Depot is also a near zero growth company, one that is expecting just 2% growth in 2013.

When you look at The The Home Depot, Inc. (NYSE:HD) as a stock you see an investment that is trading with a higher valuation than it was back during the housing boom. The stock trades at a whopping 25.0 times earnings and a price/sales of more than 1.40. This valuation is a 50% premium over the market average, therefore common sense suggests 50% better growth than the economy. However, you won’t find this growth with The Home Depot — instead you find about half as much growth as the economy, and an investment that is clearly overvalued and overhyped.

Deep Value in Restoration Hardware (Compared to The Home Depot)

In my book, Taking Charge With Value Investing (McGraw-Hill, 2013), I base much of my “finding value thesis” on a formula that compares growth and valuation to that of the economy to find “perfect value.” I show how over a period of many years, this system has been near perfect at determining a stock’s long-term trend (a year or two), also somewhat evident with my Motley Fool CAPS picks. According to this system (which was briefly discussed above in my bearish take for HD), The The Home Depot, Inc. (NYSE:HD) will see loss and will underperform the market over the next one to two years until the stock corrects.

While I do believe that The Home Depot is expensive, Restoration Hardware Holdings Inc (NYSE:RH) is about as cheap as they come! The company trades at 25 times next year’s earnings, which is greater than Home Depot’s 18 times 2014’s earnings, yet The Home Depot’s margins are near fully expanded while RH is just now beginning to see expansion. Furthermore, RH trades at a 40% discount to sales compared to HD. This, combined with the similar earnings/valuation metrics, suggests that we’re looking at two companies with similar growth/outlook.

Two Companies & Two Different Paths

The truth is that there are very few fundamental similarities between The Home Depot, Inc. (NYSE:HD) and Restoration Hardware. Home Depot has 2% growth and 2,200 stores, while Restoration Hardware Holdings Inc (NYSE:RH) is guiding for 30% growth with just 71 retail stores. The key point is that there is significant room to expand for Restoration Hardware, insinuating great fundamental upside as the company is currently exploring more than 20 different markets. Home Depot, on the other hand, has nearly completely expanded into the U.S., with few domestic market opportunities.