In this article, let's take a look at The Home Depot, Inc. (HD, Financial), a $125.31 billion market cap company, which is the world's largest home improvement retailer. The company operates a chain of over 2,200 retail warehouse-type stores, selling a wide variety of home improvement products for the do-it-yourself and home remodeling markets.
Growth catalysts
After a long time of aggressive store expansion, especially in Mexico, Home Depot is now focused on its core business and continues to improve its supply chain.
To gain market share in the domestic market, it is increasing its focus on service and customer retention. Other plans, such as concentrating on square footage growth and maximizing productivity from its existing store base, as well as focusing on developing merchandising tools and e-Commerce are good strategies to remain profitable in the upcoming future.
The firm's competitive position could be strengthening if housing prices and turnover continue to improve. Further, its economies of scale and brand equity give the firm competitive advantages over it peers.
When talking about catalyst, the cross-selling strategy, the improved merchandising technology and further penetration of selected customer product segments are the ones we see with good outlook. Moreover, strategies of expansion of existing categories could lead to more sales.
New competitors
Although new competitors could enter the industry, it would not be easy to offer similar product prices because of vendors' relationships previously established.
The biggest companies in home retailing will want to join with the biggest companies for distribution so a new competitor will not have enough capacity to satisfy demand.
Dividends
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 current dividend yield is 1.9% which is considered not enough to protect purchasing power.
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 achieving its 50% target dividend payout ratio.
Revenues, margins and profitability
Looking at profitability, revenue growth by 5.72% led earnings per share increase in the most recent quarter compared to the same quarter a year ago ($1.52 vs $1.24). During the past fiscal year, the company increased its bottom line by earning $3.75 versus $3.00 in the prior year. This year, Wall Street expects an improvement in earnings ($4.50 versus $3.75).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| HD | Home Depot | 43.00 |
| LOW | Lowe's Companies Inc. | 19.29 |
| KGFHY | Kingfisher PLC | 11.22 |
| Â | Industry Median | 9.09 |
The company has a current ROE of 43% which is higher than the industry mean and the ones exhibited by Lowe's Companies Inc. (LOW, Financial) and Kingfisher PLC (KGFHY, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, this is an excellent option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 23.4x, trading at a premium compared to an average of 23.1x for the industry. To use another metric, its price-to-book ratio of 10.42x indicates a premium versus the industry average of 1.98x while the price-to-sales ratio of 1.63x is above the industry average of 0.82x. All these metrics indicate that the stock is relatively overvalued.
As we can see in the next chart, the stock price has an upward trend in the five-year period. Also, the company has demonstrated a pattern of positive earnings per share growth over the past years. If you had invested $10,000 five years ago, today you could have $35,111, which represents a 28.6% compound annual growth rate (CAGR).
Final comment
As outlined in the article, the company focuses on its core orange box concept, improving productivity and increasing market share. Although the biggest risk is a slowdown in the cadence of improvement in the real estate market, we feel bullish about this stock in the long-term, in a stock with more than $78 billion in revenue, which is constantly updating its distribution network.
For the reasons discussed in this article, I would recommend to add this stock to long-term portfolios.
Hedge fund gurus like Jean-Marie Eveillard (Trades, Portfolio), Ron Baron (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Bill Nygren (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Ruane Cunniff (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
