Can This Home Improvement Retailer Improve Your Portfolio?

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Home Depot (NYSE: HD) is the biggest home improvement chain in the country, and has returned 20% gains to investors just to start 2013, including dividends. In addition, rising home sales and consumer confidence are playing into the thesis that Home Depot’s business is thriving.

After such strong performance, both in terms of the company’s underlying results as well as its stock price, should investors jump on the Home Depot bandwagon?

U.S. housing showing signs of life

The housing market continues to improve, as evidenced by a variety of housing-related data points, which can only mean good things to come for Home Depot. According to the Standard & Poor’s Case-Schiller housing index, home prices rose 1.1% in March. This exceeded expectations and represented the biggest annual gain in nearly seven years.

Furthermore, existing home sales increased 4% in May, reaching the highest level since November 2009, according to the National Association of Realtors.

It stands to reason that as the housing market improves and consumers feel better about their homes and their personal finances, spending on housing should increase.

Industry-leading performance

These industry tailwinds are already being felt in Home Depot’s underlying results. Last year was a terrific one for the company. 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.

In addition, Home Depot’s success has continued to start 2013. The retailer’s first-quarter same-store sales, which include only those locations open at least one year, increased 4.3% year over year. Meanwhile, diluted earnings per share soared 22% from the same period one year ago.

Unfortunately, not all home improvement chains are created equal. Close peer Lowe’s (NYSE: LOW) has not seen great results in recent quarters.

First, 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. Then, Lowe’s provided a disappointing first-quarter report that revealed its sales fell 0.5% from the same period one year ago.

Furthermore, while the company’s first-quarter earnings per share rose 14% year over year, the results missed analyst expectations.

Building shareholder wealth

A huge plus for Home Depot’s shareholders is that the company is firmly committed to sharing its success with investors. Earlier this year, the company raised its dividend by 34% and authorized a $17 billion share-repurchase program.

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.

Should you buy Home Depot?

Home Depot is an extremely strong company executing on its growth targets. The company is clearly performing much better than its close rival Lowe’s within the home improvement retailer landscape. To illustrate, consider that the recently released quarterly results marked the 16th straight quarter that Lowe's posted weaker same-store sales than Home Depot.

On a stand-alone basis, Home Depot is a classic example of a business that is better than its stock. Home Depot has racked up impressive share price gains in recent months, and as a result, trades for a fairly unattractive price.

The stock is off its recent multi-year highs, but still exchanges hands for more than 23 times trailing earnings, well ahead of the broader market’s valuation.

Moreover, while the company’s dividend growth has been fantastic in recent years, Home Depot yields just 2.1%, less than the yield on the 10-Year U.S. Treasury Bond and only about on par with the yield on the S&P 500 Index.

As a result, I’d advise patient value investors to wait for a more meaningful downturn of 10%-15% in Home Depot shares before pulling the trigger.

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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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