Better Buy: The Home Depot, Inc. vs. Target

The retail industry is an increasingly dangerous place in which to invest. Changing consumer shopping habits are decimating once-venerable businesses, and new titans are emerging to replace the old guard.

Yet in this dynamic arena, opportunities exist for intrepid investors -- if you know where to look. In this regard, let's evaluate Home Depot (NYSE: HD) and Target (NYSE: TGT) to see which is the stronger investment opportunity today.

Financial strength

As e-commerce continues to disrupt a large swath of the traditional retail industry, only the strongest retailers are likely to survive over the long term. Financial fortitude is therefore of the utmost importance. Let's take a look at how Home Depot and Target stack up in this regard.

While Target is the more heavily indebted retailer, Home Depot's interest and principal payments are covered many times over by its sizable cash flows. And ultimately, it's a company's cash profits that allow it to reinvest in its business to spur growth, as well as reward shareholders with dividends and share buybacks. So, with more than three times the net income and twice the free cash flow, Home Depot has the edge when it comes to financial strength.

Advantage: Home Depot

Growth

Wall Street expects Home Depot's earnings per share to rise by nearly 13% annually over the next half-decade,  driven by the company's successful omnichannel strategy, margin expansion initiatives, and massive share repurchases. During that same time, Target's EPS is projected to fall by more than 4% annually, as the retailer spends heavily to remodel its stores and strengthen its digital operations. Thus, Home Depot clearly has the edge in terms of expected growth in the coming years.

Advantage: Home Depot

Valuation

No better-buy discussion should take place without a look at valuation. Let's check out some key value metrics for Home Depot and Target, including price-to-earnings, price-to-sales, and price-to-free cash flow ratios.

On all four metrics, Target's shares are considerably less expensive than Home Depot's. That's to be expected as Target's stock has lost nearly 30% of its value over the past year as the retailer has struggled with rising costs and declining margins. During this same period, Home Depot's shares gained more than 30%, as the home-improvement titan delivered robust profit growth. Still, at current prices, Target's shares are more attractively priced. 

Advantage: Target

The better buy is...

Although Target's stock appears to be the better bargain based on traditional valuation metrics, Home Depot's greater financial fortitude and stronger growth prospects make it the superior long-term investment.

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Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool has the following options: short January 2018 $170 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.