After a Huge Dividend Increase, is This Retailer a Buy?

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Home Depot (NYSE: HD), the biggest home improvement store chain in the country, jumped 6% higher on Feb. 26 after reporting that its fourth-quarter net income rose 32% on the strength of U.S. sales and the cleanup that followed Superstorm Sandy.  In addition, rising home sales and consumer confidence also played into the thesis that Home Depot’s business is thriving.  Even better, the company raised its dividend by 34% and authorized a $17 billion share-repurchase program.  In light of all this, is Home Depot a bargain at its current price?

Home Depot reported sales of $18.2 billion for the fourth quarter of fiscal 2012, a strong 14% increase from the fourth quarter of fiscal 2011. It’s worth noting that the fourth quarter of fiscal 2012 consisted of 14 weeks compared with 13 weeks for the prior year, but even excluding the extra week, fourth-quarter sales still increased by 6.3% year over year.

Earnings per diluted share in fiscal 2012 were $3, compared to $2.47 per diluted share in fiscal 2011, an increase of 21.5% year over year. These results reflect a nonrecurring charge of $0.10 per diluted share.  On an adjusted basis, earnings per diluted share in fiscal 2012 were $3.10, representing an increase of 25.5% versus the prior year.

Stronger Performance than its Closest Peer

Fellow home improvement retailer Lowe’s (NYSE: LOW) was also higher on the day of Home Depot’s results.  Lowe’s shares a similar valuation profile as Home Depot, trading for approximately 22 times its trailing twelve month earnings per share.  Lowe’s offers a dividend as well as Home Depot, but the yield on Lowe’s is below 2%, unlikely to lure in many income-oriented equity investors.

Lowe’s released fourth-quarter results of its own the same week as Home Depot.  For its part, the company reported diluted earnings per share for the fourth quarter and full fiscal year of $.26 and $1.69, respectively.  Full-year sales inched up less than 1% versus 2011.  Slow sales growth hasn’t stopped shares of Lowe’s from rallying:  the stock is sitting at all-time highs, having increased more than 40% since the beginning of 2012.

Like Home Depot, Lowe’s is determined to return the company’s cash flow to shareholders in the form of dividends and share buybacks.  For the fiscal year, the company repurchased $4.35 billion or 146 million shares of common stock and paid $704 million in dividends.   Furthermore, the Board of Directors has authorized the repurchase of up to $5 billion of the company’s common stock, expected to be completed over the next couple years.

Home Depot’s value proposition

To be fair, Home Depot isn’t a screaming bargain.  New investors are paying almost 22 times the stock’s 2012 diluted earnings per share.  In addition, even including the massive dividend increase, Home Depot’s dividend yield is currently 2.3% annually, a good rate but not much higher than the yield on the broader market.  That being said, Home Depot enjoys much higher sales growth and a bigger dividend yield than its closest competitor Lowe's.

Investors seem to be increasingly optimistic about the recovery in the American housing market, a critical piece of Home Depot’s business.  In its earnings announcement, Home Depot made a point to acknowledge it is seeing gaining momentum in Florida, California and Arizona — among the states hit hardest by the U.S.’s housing-market downturn.  As a result, it’s entirely reasonable to believe that Home Depot deserves its current above-market valuation due to solid future growth expectations.

Home Depot is a highly profitable stock that is sure to benefit handsomely should the economic (and particularly housing) recovery in the United States gains further traction.  Home Depot is the largest and most well-known home improvement retailer in the world.  If you’re a die-hard dividend investor only interested in stocks commanding yields several percentage points better than the yield on the S&P 500, Home Depot may not be for you.  But if you’re an investor interested in a mix of decent income and exposure to the global economic recovery story, Home Depot is worthy of your further consideration.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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