Why You Should Buy This Big Box Store

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Home Depot (NYSE: HD), the largest home improvement retailer in the country, posted a remarkable quarter, beating expectations on revenue and bottom line income. But what really drove Wall Street to this hot stock was in the details: a higher dividend payment and huge buy back program. 

The company's recent performance only confirms why Home Depot is the best big box stock.

Home Depot's big payout

Investors should cheer Home Depot's aggressiveness with repurchases and dividend increases. The quarterly dividend now rests at 39 cents per share after years of consistent increases. It announced it would target a dividend payout ratio of 50% going forward.

Home Depot will also significantly reduce the number of shares outstanding as part of a $17 billion spending spree on its own stock. At the most recent trading price, total share count would fall by one-sixth, enriching current shareholders and boosting EPS.

Home Depot remains one of the best shareholder-friendly companies in the retail space. Since 2009, total diluted shares outstanding plummeted by 18% from 1.85 to 1.52 billion shares. Meanwhile, the company increased its quarterly per share dividend from $.23 to $.39. A new plan to hike the dividend and slash total shares outstanding will only further boost value creation for shareholders.

Why Home Depot is worthy of an investment

Few companies are as return-on-capital focused as Home Depot, which explains why return-oriented investors like Warren Buffett are so heavily invested in the Atlanta-based retailer. Buffett's Berkshire Hathaway has a minority interest in the home improvement store.

Compare Home Depot's business to other retailers like Wal-Mart (NYSE: WMT) or Target (NYSE: TGT). While those stores both benefit from economies of scale, there isn't much that Wal-Mart or Target sells that can't be purchased from deep online discounters and retailers like Amazon.

Home Depot seemingly owns its niche, competing only with Lowe's (NYSE: LOW) in a category that demands a retail storefront in order to economically move product from distributor to end user. No other retailers have that kind of insulation from technological change. Whereas you might buy your next coffee maker online at a discount, the same economics aren't in play for heavy appliances, plywood, or buckets of paint – Home Depot's specialty.

Home Depot's formidable moat and shareholder-friendly policies are exactly why the company should trade at a premium to other big box retailers. Home Depot sports a 10-year average return on invested capital of 14.1%, compared to Wal-Mart's 11.7%. Lowe's and Target offer investors only spotty single-digit returns, implying that a single dollar invested in either firm's operations would grow slower than a dollar invested in Home Depot. At a forward earnings multiple of 15, Home Depot is cheap compared to slower-growing, less shareholder-friendly Target and Wal-Mart, which trade at 10 times forward earnings expectations. 

Finally, the earnings Home Depot generates are very similar to free cash flow generation, enabling it to use more of its headline earnings to repurchase shares and pay lofty dividends. In the last 10 years, free cash flows have been equal to 90% of accrual earnings - impressive for a asset-intensive retailer.

Long-term investors should take notice. While the company shares are pricier than they were this time last year, the company's ability to generate long-term value is unmatched in the retail space. Investors who buy and hold will benefit tremendously from internal compounding as the company slowly takes itself private with rapid repurchases. 

valuemagnet 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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