If I had a time machine and could go back 40 years, The Home Depot (NYSE: HD) would be on my list of stocks to buy. The company reimagined what a home improvement store could be, with its expansive spaces that stock more products than traditional stores. This enabled rapid expansion to more than 2,300 locations today.
A $10,000 investment in The Home Depot stock 40 years ago would be worth almost $15 million today. And reinvesting dividends would have resulted in an investment worth more than $25 million.
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Shares of The Home Depot are near their all-time high of over $415 at the time of writing. But as spectacular as long-term returns have been, they have cooled in recent years. Home Depot stock has delivered a total return of 112% over the past five years.
That’s still a solid result, but there’s new stock to watch in the home improvement space. Shares of flooring specialist Floor & Decoration (NYSE: FND) are up 147% over the past five years, and this little-known stock could outperform The Home Depot over the next five years as well. This is why.
An investment thesis is the primary explanation for why a stock will rise (or fall). For Home Depot, it has opened just 55 net new stores over the past five years, a growth rate of only about 2%. This isn’t surprising considering how big it already is, but it does limit the company’s chances for revenue growth.
The investment thesis for Home Depot stock therefore largely revolves around profit margins and shareholder returns. In terms of profit margins, the company is already among the best in the industry with a net margin between 9% and 10%. That also leaves little room for improvement – margins can only be so high in this competitive retail category.
One of the main ways Home Depot stock creates value is by returning cash to shareholders through dividends and share repurchases. This can be powerful in the long run, and don’t get it wrong: Home Depot is a great company, and many investors rightly plan to continue owning shares. But there is more room for improvement at Floor & Decor, which is why I believe the stock offers greater upside potential.
It’s not just a theory: Floor & Decor stock has outperformed Home Depot stock over the past five years as its revenue and operating profit grew faster, as the chart below shows.
Floor & Decor’s continued path to revenue growth is simple. It has 241 locations today and should end the year with about 250. Next year it plans to open another 25 – that’s good for unit growth of 10%. And in the long term, the plan is to have 500 stores across the country.
Same-store sales have recently fallen for Floor & Decor; management expects this to decline by approximately 8% for the full year. But that is unusual and is probably mainly caused by a weak housing market. In 2022, the company completed its fourteenth consecutive year of profit.
Lower same-store sales have also depressed Floor & Decor’s profit margin. It is currently below 5%, while previously it was between 7% and 8%.
According to the National Association of Realtors, home sales in September fell to the lowest level since 2010. It’s fair to assume this is to blame for Floor & Decor’s sluggish sales. The problem should correct itself within the next five years. And if it does, same-store sales should rise again, which would also increase the company’s margins.
With new store openings, same-store sales growth and profit margin expansion, I believe Floor & Decor will not only outperform Home Depot over the next five years, but S&P500 also.
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Jon Quast has positions in Floor & Decor. The Motley Fool holds and recommends positions in Home Depot. The Motley Fool has a disclosure policy.
Shares of this little-known home improvement company have outperformed Home Depot shares over the past five years. This is why I expect this trend to continue over the next five years. was originally published by The Motley Fool
