Best Stocks to Buy Right Now: Costco vs. Home Depot

Investors are undoubtedly familiar with these dominant retailers.

Costco Wholesale (COST 0.68%) has been a big winner for investors. The shares are up 238% over the past five years, a much better gain than the S&P500. And they are currently at an all-time high.

It was a different story before DIY store (HD -2.05%). The home improvement chain’s shares have underperformed the S&P 500 over the past five years, trading 20% ​​below their peak price.

Which of these two leads retail inventories is now the better buy?

Enthusiastic investors

With Costco stock trading at record levels and mimicking the broader market indexes, it’s fair to say that investor enthusiasm and bullishness toward the company has never been higher. This becomes clear when we look at the valuation.

At the time of writing, the stock is selling at a price-to-earnings ratio (P/E) of 50. This is about the same price as what the stock has sold for in the last 25 years. And shares are trading at a 46% premium to their ten-year average.

Some might argue that Costco deserves this sky-high rating. The company has taken care of its shareholders with impressive returns and special one-time dividends. The scale creates a powerful competitive advantage that allows Costco to sell high-quality goods at extremely low prices. A membership model leads to customer loyalty. And Costco has proven that it can steadily increase sales and profits, regardless of economic conditions.

I don’t agree with all these positive qualities. But I’m in the camp that believes Costco’s future returns are unlikely to exceed those of the S&P 500. Executives will obviously run out of locations to open new warehouses, especially at the same pace as when the company was much smaller . As a result, sales growth should slow in the coming years.

According to Wall Street analyst consensus estimates, Costco’s revenue and diluted earnings per share are expected to grow at a compound annual rate of 6.3% and 11.2%, respectively, between fiscal 2023 and fiscal 2026. That doesn’t come close to justifying the current valuation. .

Macro headwinds

After double-digit revenue increases in fiscal 2020 and fiscal 2021, Home Depot’s business has suffered a notable slowdown. Executives point to the unfavorable macroeconomic environment as the culprit, as inflationary pressures discourage consumers from taking on larger renovation projects. This helps explain the 3.2% decline in same-store sales in fiscal 2023. Management expects this figure to decline by 1% in the current fiscal year.

However, I view these challenges as temporary in nature. Although Home Depot is the clear leader in the $1 trillion home improvement industry, it only has a 15% market share. The fragmented nature of the industry means that a large-scale operator, one with brand recognition, unrivaled inventory availability and extensive reach with its more than 2,000 stores nationwide, can steal market share over time.

Investors will also appreciate Home Depot’s continued commitment to returning capital to its shareholders. Last fiscal year, the company paid $8.4 billion in dividends. And it bought back $8 billion worth of stock. The consistent generation of free cash flow means that this capital allocation policy is safe.

It also helps that Home Depot stock is reasonably priced. They trade at a price-to-earnings ratio of 22.5. This roughly corresponds to the ten-year average. And it represents a small discount versus the broader S&P 500.

Clearly, Home Depot is more sensitive to macro conditions than Costco. And this has not been more in the spotlight than it is now. But I believe the former’s valuation and attractive sector background create a more attractive investment opportunity today. Investors just need to maintain a long-term horizon.

Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Costco Wholesale and Home Depot. The Motley Fool has a disclosure policy.