Should You Buy Home Depot Inc (HD) Stock? 3 Pros, 3 Cons

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Retailers have had a very bad year. From big-box stores such as Target Corporation (NYSE:TGT) to the specialty mall players, just about every brick-and-mortar player has taken a hit. Amazon.com, Inc. (NASDAQ:AMZN) continues to cast a wide shadow over most retailers.

Home Depot Stock: Should You Buy Home Depot Inc (HD) Stock? 3 Pros, 3 Cons

But one company has avoided the negativity. Home Depot Inc (NYSE:HD) hasn’t fallen victim to its sector. On the contrary, in fact, Home Depot stock just hit new all-time highs, and has doubled over the past three years. Can the run continue, or is now a good time to book profits on HD stock?

Home Depot Stock Cons

Lowe’s Is Cheaper: Home Depot has a lot going for it, but you have to pay up to buy its stock. Let’s compare it with Lowe’s Companies, Inc. (NYSE:LOW).

Yes, they both trade at the same trailing price-to-earnings ratio today. However, Lowe’s is at a forward PE of 16, compared to 18 for Home Depot stock. That’s a meaningful difference. On a price/sales ratio, Home Depot comes in at an elevated 1.9x, compared to a normal-for-retail 1.1x at Lowe’s.

Lowe’s lower profit margins justify some, but certainly not all, of the gap. Home Depot also has minimal tangible value, trading at a 41x price/book ratio, compared with 12x for Lowe’s.

Stock Up Sharply: Since November, Home Depot stock has rallied more than 20%. Over the past four years, it has doubled. If you’re a momentum trader, those figures may excite you.

But if you’re looking for value in your purchases, there is a good chance you are late to the party. Even great companies’ stocks don’t go up in a straight line. After such a huge run in HD stock, it would be normal for shares to take a breather or even decline in spite of strong fundamentals. The broader market has also rallied almost without pause. This far into a huge run, be prepared for volatility.

Federal Reserve May Hurt Housing: The United States’ housing market is currently on fire. 2016 delivered the strongest full-year sales results since the crisis. I discuss this further in the Pros, it’s currently a big plus for the stock. But Janet Yellen may slam the brakes on the housing market.

The Fed raised rates this past week, and suggested that we should expect two more hikes in 2017. If these occur, it would likely lead to a substantial rise in longer-term interest rates. This would push up mortgage yields, making homes less affordable for buyers. Given the generally sluggish rate of wage growth, and millennials’ economic struggles, the last thing the housing market needs are rapidly rising rates. One or two hikes wouldn’t reverse the current upswing in housing. But if the Fed is intent on getting back to normal interest rates by 2019, as they suggested in their latest meeting, it would provoke a major slowdown in housing activity.

Home Depot Stock Pros

One of the Market’s Best Long-Term Investments: Home Depot stock has performed incredibly over the past 30 years. If an investor put $10,000 into Home Depot stock in March of 1987, exactly 30 years ago, it’d be worth $3.9 million today, according to this calculator. That’s a jaw-dropping 22% annualized gain over a three-decade span. Invest once, don’t sell, and retirement is set.

Of course, past performance doesn’t guarantee future results. In fact, given Home Depot’s large size today, it would be exceedingly difficult for the company to achieve a repeat performance. However, the company’s excellent capital allocation practices and relatively high-moat business advantages should remain durable. An investor who bought $10k of Lowe’s stock at the same date in 1987 would have turned their money into $1.1 million over the same span. Also a great return, showing the strength of the home improvement sector, but HD stock did much better.

Huge Dividend Hikes: With strong capital gains often come huge dividend hikes. Home Depot follows the rule. The company has posted a stunning 22% compounded growth rate over the past five years, and 14% compounded over the past 10 years. In 2011, Home Depot stock paid a dividend at a $1 per year annual rate. Just six years later, HD stock is now throwing off $3.56 per share.

The most recent jump actually managed to accelerate the trend. Home Depot stock is now sporting a fully 29% larger dividend, as the company hiked the quarterly pay rate from 69 cents to 89 cents per share. For a company as mature and large as Home Depot, the increase should impress investors greatly.

Yes, some people will say the 2.4% current yield isn’t large enough to pay the bills. But consider that Home Depot stock purchased in 2007, just before the greatest housing crisis in U.S. history, now yields 7.3% on cost. Hold HD stock for more than a few quarters, and the yield tends to grow into something substantial.

Strong Economic Environment: Home Depot stock continues to power higher due to strength in the housing industry. The 2008 housing bust caused homebuilders to pull back too sharply on activity in subsequent years. Their timidness left the United States’ housing market badly under-built. That lack of supply has sent home prices soaring. Homebuilding activity has now finally hit levels last seen in 2007.

The accelerating housing market has lifted demand for home improvement supplies. There’s little sign this trend is letting up. Even higher interest rates have yet to dent the market’s momentum. And, as a result, both Home Depot and Lowe’s have released strong earnings figures recently. Don’t overthink things — home improvement stores will continue to shine as long as the housing bull market proceeds at its current pace.

Verdict

Home Depot looks like a fairly priced stock. The company represents an American blue chip at its finest. Its management allocates capital legendarily well, and takes care of shareholders with gigantic dividend raises. The current housing boom further lifts the company’s prospects.

However, the market realizes how well Home Depot is doing. Today’s price doesn’t come close to offering up a bargain on shares.

If you’re willing to pay a rich price for a great company, Home Depot isn’t a bad pick. Shares could slump, however, if momentum reverses even slightly in the short-term.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned stocks. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


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