In an industry dominated by two neck-and-neck rivals whose stock prices have boomed since 2010, who belongs in your portfolio? I’m talking about the home improvement industry, and, of course, The Home Depot, Inc. (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW). While deciding between these two involves many aspects of each company, I’m going to bring three metrics to the table to help you decide which one may be right for you. These metrics are not enough to pick one stock or another alone, but can help educate you on three ways to help evaluate a company. So, let’s start with the first: Asset Utilization.
Asset Utilization
Measuring a company’s asset utilization is one of my favorite metrics to use, and it is great way to measure the efficiency of a company. In determining which of these three companies may belong in your portfolio, there are obviously countless factors, and efficiency is one of many things to take into account. However, for the sake of analyzing the companies broadly, asset utilization is one of the ways I will be using.
Asset utilization, for those who do not know, calculates a company’s total revenue earned for each dollar of assets that the company owns. For example, a ratio of 70% means that the company earned $.70 for every dollar of assets that it holds. A higher percentage tends to indicate a higher efficiency with this ratio.
While it is not always pinpoint-accurate, the ratio does usually give us a good indication of how each company is in terms of efficiency. So, given that, let’s take a look at the graph:
As you can see, both The Home Depot, Inc. (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW) are incredibly efficient, both boasting well over 100% efficiency. However, typically the ratio is more effective when using it to compare two companies side-by-side. Furthermore, it helps to use the ratio over a history of a few years, as opposed to just a current value. An increasing asset ratio over time indicates a company being more efficient with every dollar of assets. Since 2010, The Home Depot, Inc. (NYSE:HD)’s asset utilization has increased about 13%, as opposed to about a 3% increase for Lowe’s. This shows that Home Depot is steadily increasing their efficiency over time, which, coupled with simply a higher overall asset utilization, gives Home Depot the edge here, meaning that Home Depot could be a better long term bet in your portfolio.
KZ Index
To me, this ratio is incredibly important for specific industries, and not as important for others. Obviously, I believe it is very important to the oil industry, and here is why: the KZ index measures how a company might fare should conditions “tighten” financially. More specifically, the KZ index, or Kaplan-Zingales index, measures, relatively, a company’s reliance on external financing to determine which companies may be more likely than others to experience difficulty financing ongoing operations should conditions worsen. In the oil industry in which prices and technologies are constantly changing, this is incredibly important.
The calculation of the ratio is incredibly long and complicated, so I left it to the computers to do it for me, but if you are interested in knowing the specifics behind calculating it, you can look here.
Let’s look at the chart:
For this ratio, a lower score represents a lesser probability of financial difficulty during tightened economic conditions.
It’s important to remember that all scores with this metric are relative. So, looking at the results of for the two home improvement companies, Home Depot rings in at -.6347, while Lowe’s Companies, Inc. (NYSE:LOW) at .1709. I know these numbers mean nothing yet, so let’s analyze what they mean.
A lower score is considered more ideal with this metric. A score of -14.43 puts companies in the 90th percentile, meaning that only 10% of companies have better scores than that; whereas a score of 10.12 means that 90% of companies have a better score, with a pretty crazy curve in between.
While The Home Depot, Inc. (NYSE:HD) does come in almost one full point lower (better), their score puts them in the 57th percentile, meaning just 43% of companies have better scores. However, Lowe’s Companies, Inc. (NYSE:LOW) is in the 54th percentile, hardly worse than their rival, and both companies are above average.
The index shows us that neither company would likely encounter financial difficulties; however, Home Depot has a slight advantage should things go awry.
Finally, let’s look at the third ratio I’ve chosen.
Tangible book value per share
Tangible book value per share, or TBVPS, is a measurement of the portion of tangible assets (all assets, with the exception of goodwill and items classified as “intangible” on a company’s balance sheet) attributable to each share of the company’s common stock. What this means is that it is helpful in establishing the valuation of a company, and whether or not it may be over or undervalued. This is important because lots of company’s balance sheets can reflect asset valuations that are inflated by intangibles; yet, if a company were to go bankrupt, the tangible value of assets a company has would be what is left over after bankruptcy. A simple way to put this would be that tangible book value answers the question, “as a shareholder, what would I receive if the company had to liquidate all of its assets?” By measuring this value per share, we create a ratio that measures valuation.
A TBVPS larger than the current price of the stock means that the stock could be potentially overvalued, whereas, obviously, a TBVPS smaller than the stock could mean that the stock is potentially undervalued. Formulaically, for those who are interested, TBVPS is equal to: (Tangible Book Value – Book Value of Preferred Stock) / Common Shares Outstanding. Now, let’s look at each company’s TBVPS in relation to their stock price.
As you can tell, both are potentially overvalued. So, which could be the most overvalued? To do this, we can simply divide the TBVPS by the current stock price, where the lowest TBVPS / Price would represent the company potentially the most overvalued.
| TBVPS | Price | TBVPS / Price (valuation) | |
|---|---|---|---|
| Home Depot | 11.11 | $70.97 | .157 |
| Lowe’s | 12.32 | $38.04 | .324 |
So, according to this metric, Home Depot would be the most potentially overvalued, with a very low .157 TBVPS / Price. However, Lowe’s valuation is not exactly impressive either. Still, they gain the slight edge over Home Depot here, giving them a short-run advantage.
Foolish bottom line
Obviously, there is much more at stake than these three metrics, and no company should be added to a portfolio based on solely these three things. However, these should help as a guideline when deciding between companies in an industry. My hope here was to help introduce you to a few not-so-common ways to evaluate a company that are still very useful.
So, in the end, who won? Well, The Home Depot, Inc. (NYSE:HD) won 2/3 of our “contests,” putting them in the lead, with Lowe’s winning just 1. That certainly isn’t a knock against Lowe’s Companies, Inc. (NYSE:LOW). In fact, Lowe’s did win our one short-term-based metric, whereas Home Depot won with the metrics centered more on the long term.
Still, these three metrics are not enough criteria alone to make a buy or sell decision. However, they should help educate you about three little-known metrics that can be very helpful in evaluating a company.
The article The Home Improvement Industry According to These Three Metrics originally appeared on Fool.com and is written by Michael Nolan.
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