Home Depot Stock Valuation (HD)

Home Depot Stock Valuation (HD)

buy home depot stock

Investment Thesis

Home Depot (HD) is a stable mature company that has consistently paid out dividends for the past 31 years. Their strong dominant business in the home improvement industry is driven by continuously strong sales growth, year-over-year. Home Depot is currently trading 24% above its 52-Week low and at 76% of its 52-Week high. They’ve continued to raise their dividend payouts while simultaneously being involved in large share buyback programs. Given this information, this might be the time to buy Home Depot stock for the dividend portfolio.

Why Home Depot?

Home Depot surprised me when I looked up the underlying stocks for the Millenials ETF (MILN). You have your standard Netflix, Facebook, and Starbucks stocks in MILN. But then I came across Home Depot and thought “really? Home Depot is considered Millenial?” I agree that buying all these other stocks would be investing in Millenials but I never would have though to buy Home Depot stock.

Then I realized that other MIllenials my age are buying homes and improving them. This made sense to me. Many of my friends own homes and many of them are your typical do-it-yourselfers. They spend time at Home Depot, Lowe’s, Walmart, all buying supplies and doing it themselves.

As such, I figured Home Depot warranted further research.

Home Depot vs the S&P 500

Since 1994, Home Depot stock has steadily risen from $8.78 per share to $183.29 per share, a compound average growth rate (CAGR) of 14.40%. In the same time period, their dividends have increased from $0.006667 per share to $1.03 per share. Their current dividend yield is 2.40%, beating the S&P dividend yield of 2.30% (source: dividend.com). Below is a graph that illustrates Home Depot’s outstanding performance over the S&P from 1994 to 2018.

home depot stock vs S&P 500

Source: Created Using PortfolioVisualizer

According to the graph, if you had invested $10,000 in 1994, it would have grown to $288,839 with dividends reinvested. Home Depot has a higher standard deviation than the S&P 500, and thus higher volatility and price swings. However, its higher level of riskiness is compensated by its extraordinary returns. Home Depot’s best year returned a whopping 108.45%.

Home Depot is the world’s largest home improvement retailer based business. They provide building materials, home improvement products, lawn and garden products, and a number of home improvement services. They currently have 2,284 stores open worldwide which represents an increase from 2,274 stores in 2015 and 2,278 stores in 2016.

Home Depot is a strong stable company that has increased their dividends for over 30 years. To analyze the power of their dividends and compounding, Home Depot allows you to back test using their calculator located on their investor’s relations site. According to this calculator, if you bought 1 share of HD on January 1, 1999, for $40.79, you would have had a 476.54% with dividends reinvested, or an annualized return of 9.17%.

home depot investment calculator

Source: Home Depot Investment Calculator

Alternatively, if you instead invested in the market using the SPY ETF, then you would have only produced a total return of 220.71%. This represents an underperformance by over 200%.

Fundamental Analysis

Income Statement

According to their latest 10-K filing, their net sales from 2015 to 2017 have increased an average of 6.77% per year with earnings per share (EPS) increasing by an average of 15.58% per year during the same time period.

home depot net sales

Source: 10-K

We noted that this was mostly due to the increased in sales on the income statement. The operating expenses incurred by Home Depot were relatively stable during the last 5 years as shown below.

home depot income statement

Source: Morningstar

We believe that as Home Depot continues to experience stronger sales while expenses remain stable, thus supporting our clause to buy Home Depot stock. The operating income margin will widen, delivering higher EPS to its shareholders. With over $100 billion in sales and 2,284 stores, that represents an average of $44.18 million per store. Its previous sales per store was $41.53 million. This growth shows an increase of $2.653 million per store.

Additionally, looking at their most recent quarterly earnings report, we found that sales totaled $81,712 million for the nine months ended on October 28, 2018 , a 6.09% increase over $77,021 million during the same period last year. Operating income rose by 5.74%. What’s fascinating is that both net income and EPS rose by double digits: 28.11% increase in Net Income and 32.47% in EPS compared to the same period in the previous year.

 (in USD millions) Nine Months Ended
10/28/2018 10/29/2017 Growth
Sales 81,712 77,021 6.09%
Operating Income 12,152 11,492 5.74%
Net Income 8,777 6,851 28.11%
EPS 7.67 5.79 32.47%

Source: 10-Q

Statement of Cash Flows

Home Depot is a cash generating machine that has been increasing its cash holdings year-over-year. It has had continuous positive free cash flow over the last five years, with significant increases in its operating cash flow. This allows Home Depot to remain very liquid and able to withstand any market turmoil. Its investing cash flow has been primarily used in capital expenditures and business acquisitions. Its financing cash flows consist mainly of share repurchases, dividend payouts, and debt repayments.

In its most recent 10-Q, Home Depot reported a 3% increase in operating cash flow, from $9,741 million in the previous year to $10,036 million in October 2018. Their cash flows used to pay out financing activities increased in 2018 which reduced their overall free cash flow and cash balances. This was a result of paying back debt, large share repurchases, and paying out dividends. All three of these are beneficial to the long-term investor as the company is reducing credit risk and paying out shareholders.

home depot financing cash flows

Source: 10-Q

As a result, their cash and cash equivalents dropped in Q3 from $3,549 million to $1,764 million.

Debt

Speaking of debt, Home Depot’s long-term debt liabilities have been steadily increasing over the years as well. Digging through its 10-K, we found that the majority of its debt consists of commercial paper with five-year maturities. Home Depot uses this cash for capital expenditures, acquisitions, and share repurchases. According to its 10-K, Home Depot’s weighted average interest rate on their debt is 1.45% which is an extremely low cost of debt, and therefore, pays out much lower interest payments in cash.

Their most recent 10-Q showed a decrease in both short-term debt and long-term debt. This was corroborated with their Financing Cash Flows.

Nine Months Ended
10/28/2018 10/29/2017 Reduction
Short-Term Debt 1,398 1,559 -10.33%
Long-Term Debt 23,332 24,267 -3.85%

Source: 10-Q

Financial Ratios

Given its most recent 10-Q, Home Depot showed an operating income of $12,152 million and paid an interest expense of $782 million. As a result, this means they have an interest coverage ratio of 15.54. In other words, Home Depot’s most recent operating income allows the company to cover over 15 years’ worth of interest expenses. This in addition to their $1,764 million of cash on the balance sheet allows the company to remain solvent for some time.

It’s Enterprise Value / EBITDA ratio is currently 12.38 on Yahoo! Finance. The average EV/EBITDA ratio for a stock in the S&P 500 has been between 11 and 14 over the last few years. The lower the ratio, the higher the EBITDA or the more undervalued the company.

Its debt-to-equity ratio has recently spiked up to 17.68 due to its financing debt for acquisitions and share repurchases. Its historical debt-to-equity has been below 5.

home depot debt-to-equity

Source: Macrotrends.net

However, its return on assets has been steadily rising due to its sales growth and growth in net income. Its total assets have remained relatively stable. As a result, its most recent return on assets value is 23.12%

home depot return on assets

Source: Macrotrends.net

Based on the chart below, its return on equity has been even more impressive with its latest value being 652.61%. Home Depot’s ROE has also been steadily rising over the last few years due to a combination of both the decreasing equity and rising net income. Return on equity is one of the popular metrics when determining to buy Home Depot Stock.

home depot return on equity

Source: Macrotrends.net

Technicals

From a technical analysis perspective on monthly chart, Home Depot has been riding above the 20-day moving average since after the financial crisis. The most recent 3 months saw a steep drop as the markets faced sharp declines. Home Depot’s current position is pivotal as the next few months will dictate whether it can stay above or below the 20-DMA. Technical traders should watch this spot for conviction of its next direction as it’s currently serving as a support level. This might be a good time to buy Home Depot stock if you’re a long term investor and believe that this is a good support level. On the upper boundary, Home Depot saw resistance around the 210 and 215 price points. If it does manage to rise up there again, those would be vital points to observe to see if it can go any higher.

Source: FreeStockCharts.com

Is It Time To Buy Home Depot Stock?

In conclusion, I believe market dips present potential opportunities to buy Home Depot stock. Customers will continue to buy items to improve their homes and their properties. Home Depot is positioned to withstand hard market conditions with its massive amounts of liquidity and low interest payments. It’s been paying dividends consecutively for years and has stood the test of time during recessions.

 

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