Is Home Depot Destined for Greatness?
Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Home Depot fit the bill? Let's look at what its recent results tell us about its potential for future gains.
What we're looking for
The graphs you're about to see tell Home Depot's story, and we'll be grading the quality of that story in several ways:
Growth: are profits, margins, and free cash flow all increasing?
Valuation: is share price growing in line with earnings per share?
Opportunities: is return on equity increasing while debt to equity declines?
Dividends: are dividends consistently growing in a sustainable way?
What the numbers tell you
Now, let's take a look at Home Depot's key statistics:
HD Total Return Price data by YCharts
Revenue growth > 30%
Improving profit margin
Free cash flow growth > Net income growth
30% vs. 64.5%
Stock growth (+ 15%) < EPS growth
166% vs. 85.5%
*Period begins at end of Q1 2010.
HD Return on Equity data by YCharts
Improving return on equity
Declining debt to equity
Dividend growth > 25%
Free cash flow payout ratio < 50%
*Period begins at end of Q1 2010.
How we got here and where we're going
Home Depot builds a pretty solid foundation by earning six out of nine possible passing grades. One of those falling grades only happened because net income growth has outpaced free cash flow during our tracking period -- a common occurrence with corporate earnings these days -- but the raw numbers show that Home Depot's trailing 12-month free cash flow is higher than its net income. A significant amount of debt raised during the year has certainly cost it a debt-to-equity passing grade. None of these shortfalls are insurmountable. But does today's result mean Home Depot will keep outperforming in the future? Let's dig a little deeper.
It seems increasingly obvious that the U.S. housing market is gaining momentum again. In certain areas of the United States, the amount of money spent on a mortgage remains cheaper than the price of rent, even four years after the housing crash supposedly bottomed out. Even if interest rates rise, they would still be dawdling near historic lows, which certainly has its appeal to a growing number of potential homeowners -- and a tighter housing supply of late means that builders must build. When that happens, Home Depot tends to benefit, just as they would if a larger number of homeowners crawl out from beneath underwater mortgages and perform the necessary repairs to put their pads on the market.
Over the past few weeks, some investors have sold off their stocks and bonds as the Fed has begun to signal a possible slowing of its bond-buying program. Treasury yields spiked dramatically, which have caused mortgage interest rates to rise as well. In the aftermath, mortgage activity has declined -- however, if interest rates stabilize or even drop a little bit, it's highly possible we'll see a mortgage rebound as more buyers rush in to "lock in" what's undeniably still a very low rate by historic standards. Conversely, a sustained drop in mortgage activity could also wind up being a net positive for Home Depot should a number of existing homeowners simply decide to repair rather than move out.
Putting the pieces together
Today, Home Depot has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.
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The article Is Home Depot Destined for Greatness? originally appeared on Fool.com.
Fool contributor Alex Planes has no position in any stocks mentioned. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.
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