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A Recovery in the Housing Market Sounds Great for Home Depot

March 14, 2014 | About:
Victor Selva

Victor Selva

9 followers

The Home Depot Inc. (HD) is a home improvement retailer. The company operates the Home Depot stores, which stock about 30,000 to 40,000 different kinds of building materials, home improvement supplies and lawn and garden products. The company also provides over 600,000 products through its Home Depot and Home Decorators Collection websites.

So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity while the housing market is improving.

Core Business

Home Depot accelerated its expansion efforts abroad, especially in Mexico. To gain market share in the domestic market, it is increasing its focus on service and customer retention. As a matter of fact, it is in the process of making acquisitions and strategic alliances with third parties. The firm's plan is to concentrate on square footage growth and maximize productivity from its existing store base, as well as focus on developing merchandising tools and e-commerce.

Strong Cash

Looking at the financials, the company has a strong balance sheet: good cash that allows it to reward current shareholders through dividend and share repurchases. Dividend-payment history affirms its commitment to maximize shareholder wealth. In February 2014, the company raised its quarterly dividend by 21% to $0.47 per share from its earlier payment of $0.39 per share. The company has returned $27 billion to its shareholders through cash dividends and share buybacks over the past five years. It is expected to reach $17 billion of share repurchases by 2015 as well as achieve its 50% target dividend payout ratio.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 21.7x, trading at a premium compared to an average of 18.5x for the industry. To use another metric, its price-to-book ratio of 8.10x indicates a premium versus the industry average of 1.7x and the price-to-sales ratio of 1.48x is above the industry average of 0.73x. The metrics indicate that the stock is relatively overvalued relative to its peers.

Earnings per share (EPS) increased by 7.3% in the most recent quarter compared to the same quarter a year ago ($0.73 versus $0.68). It has demonstrated a pattern of positive earnings per share growth over the past two years. We include in the next graph the stock price because EPS often lead the stock price movement.

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Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has increased when compared to its ROE from the same quarter one year prior. With ROE of 25.51%, it is well above the industry mean of 9.10% and Lowe's Companies Inc. (LOW) good ratio of 14%.

Final Comment

Although macroeconomic factors (fuel and energy costs, unemployment levels and high household debt levels) always remain as a potential risk for Home Depot, I would recommend investors to consider adding the stock for their long-term portfolios. It reported better-than-expected bottom-line results for the fourth quarter of fiscal 2013. But it was not the first time, the last six consecutive quarters it reported a good surprise for the market. The firm currently has a Zacks Rank #3 (Hold) and an upgrade recommendation from Neutral to Outperform.

Hedge fund gurus have also been active in the company in Q4 2013. Louis Moore Bacon (Trades, Portfolio), Ron Baron (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Ruane Cunniff (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio) have taken long positions in the stock.

Disclosure: Victor Selva holds no position in any stocks mentioned.


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