The Home Depot Indicator

By Ryan Guenette - August 26, 2012 | Tickers: HD, LOW, LL, SHLD, GWW | 0 Comments

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The leading economic indicators for the US are not pointing in the right direction. Unemployment is on the rise, climbing to 8.3% in July. Businesses of all sizes are holding off hiring additional employees because of the uncertainty continuously revolving around their future. Consumer confidence is rebounding, but still is light-years away from reaching levels seen before the financial disaster of 2008. However there does appear to be one bright spot in the economy: housing. The massive rebound in the index of leading economic indicators was fueled by a big jump in applications for housing permits. The chart below displays the sharp rebound seen in the Home Builders Market Index.

Many companies benefit from a rally in the housing market, none more than Home Depot (NYSE: HD). On August 14^th, Home Depot reported an extremely strong quarter fueled by a turnaround in the housing market. Reporting a beat in earnings per share and raising guidance resulted in the stock rallying, achieving highs not seen since 2000. So as the Home Depot Indicator pushes towards all-time highs, is there a chance to buy shares before they hit new highs, or it is time to ring the cash register?

Concrete Strength Fundamentals

In 2002, Home Depot reported earnings per share of $1.30. In 2012, the average analyst consensus believes the company will derive $2.47 per share from its business operations. This represents an increase of 90.00% in earnings per share over a decade, a moderate accomplishment for a company that weathered the financial downturn of 2008 and the popping of the housing bubble during this period. Based on these statistics, the company’s compound annual growth rate (CAGR) is 6.63%, a sustainable rate for the largest chain of home improvement stores in the country. Additionally, Home Depot currently pays out an annual dividend of $1.16, which at the current price, puts the company’s dividend at a 2.04% yield. This is up from 2011’s annual dividend of $1.00, and is further expected to expand into the future. By 2014, the street anticipates the company’s dividend to reach $1.43, which at the current price, puts Home Depot’s dividend yield at 2.52%. From this we can see Home Depot’s underlying financial persistence through all economic environments, annualized sustainable growth rate, and expanding dividend.

The chart below displays Home Depot’s sales, operating profit, net income, net margin, operating margin, earnings per share, dividend, and rate of dividend (the percentage of net income that is paid out in the dividend) over the foreseeable future.

Further Rebound in Housing Market Could Push Home Depot Higher

While the housing market is rebounding, new home sales are still scraping all-time lows. Since the majority of Home Depot’s sales are derived from construction companies, Home Depot heavily relies on the sales of new homes, so there will be a greater demand for new houses to be built. Despite the recent financial success in the company, very little of it has come from new home sales. As the chart below displays, new home sales are not far from making new all-time lows.

If new home sales were able to at least return to the median level of 600,000 homes, Home Depot would rally extensively, as there would be a greater demand for their homebuilding materials.

Additionally, as more and more potential buyers find the historically low-interest rates and bargain home prices attractive, there will be greater need for Home Depot’s products. Buyers will want to personalize their houses, paint the walls their favorite colors, and upkeep their new investments. Additionally, sellers that have been waiting for the housing market to rebound enough for them to sell are improving their houses in hopes of increasing value. In conclusion, the housing market is turning around, and this will significantly favor Home Depot, pushing the stock to new all-time highs in the coming years.

Who is the Industry Leader?

Compared to some of Home Depot’s most prominent competitors, such as: Lowe’s (NYSE: LOW), Sears Holdings Corporation (NASDAQ: SHLD), Lumber Liquidators Holdings Incorporated (NYSE: LL), and W.W. Grainger Incorporated (NYSE: GWW), Home Depot relates favorably.

In terms of growth, Home Depot is unmatched, while Sears withers away as the time flies by. Home Depot, Lowe’s, and W.W. Grainger all pay out dividends, with Lowe’s possessing the largest and fastest growing dividend. In the fundamental ratio comparison, Lumber appears a little pricey, while Lowe’s trades at a bargain price. The same is true when growth is taken into account. In the net profit margin comparison, Sears is vastly underwater, while W.W. Grainger stands out to the upside.

The Foolish Bottom Line

The Home Depot indicator is pointing upwards. After reporting a tremendous quarter, Home Depot may appear expensive at the moment, yet the company possesses incredible financial strength, an annualized growth rate that will be sustainable into the future, and a dividend that is growing at a decent pace. Additionally, the housing market is only beginning to rebound, and further acceleration in the recovery could fuel Home Depot’s move towards all-time highs. However, Home Depot is highly linked to the economy, and a slowdown could leave Home Depot out in the cold. The foolish bottom line is that the housing market is coming back, and a tremendous way to play it is Home Depot.    

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