Home Depot (HD) Stock Is Worth the Stretched Valuation

A resurgent housing market and strong sentiment gives HD a high ceiling

The return of the housing market looks like the real deal, and that bodes well for Home Depot (HD) even as HD stock hits all-time highs and looks somewhat pricey.

Home Depot (NYSE:HD) HD stockRetail spending has been a mixed proposition this year, but not in the housing and home improvement markets. Although consumers remain highly selective about their purchases, they’ve proven willing to spend on housing and home improvement.

As the nation’s largest home-improvement retailer, Home Depot is positioned to benefit more than most.

On top of that, current economic trends make the retailer’s prospects look better than they have in years. After all, homebuilder sentiment hit a 10-year high in August. Meanwhile, U.S. housing starts are close to an eight-year high, and existing homes sales are running at their fastest pace since February 2007.

The good fortune of the housing market is flowing straight into Home Depot’s cash registers. The Home Depot earnings report revealed that the average size of a transaction returned to levels not seen since before the housing market collapsed.

Put it all together, and Home Depot earnings matched analysts’ average forecast on the bottom line and exceeded estimates on the top line. Revenues of $24.83 billion were up more than 4% year-over-year, while adjusted earnings of $1.71 per share of HD stock were 12% better. That was fueled by 4.2% same-store sales growth that trumped estimates for 3.5%.

Best of all, HD lifted its full-year outlook for the second time in 2015, expecting earnings to come in between $5.31 and $5.36 per share.

Furthermore, same-store sales — a critical measure of a retailer’s health — rose 4.2% to beat Wall Street estimates. Domestic same-store sales were even stronger.

Does HD Stock Have Room to Run?

The issue at this point is whether HD stock is overpriced. It’s not like the improvement in the housing market is a surprise. Home Depot stock is now up about 17% for the year-to-date. Heck, it’s up 8% in just the last month.

All that upside is stretching the valuation. HD stock trades at 20 times forward earnings. That’s significantly more expensive that the S&P 500, as well as its own five-year average, according to data from Thomson Reuters Stock Reports.

HD also looks a bit rich by price-to-sales. A multiple of 1.8 is high for a retailer. That also represents a large premium to the broader home-improvement industry.

That said, HD stock still looks worth the price. True, it’s more expensive than the broader market, but then it has much better growth prospects.

More importantly, valuation is very much a reflection of investor sentiment, and sentiment is clearly on Home Depot’s side. The housing market is a standout in an otherwise okay-but-poky economy, and that makes HD stock an obvious play on the domestic consumer.

At the same time, a good chunk of the rest of the sector is struggling with mixed retail spending and increased competition from e-commerce. It’s just not that easy to find winners among large-cap retail stocks these days.

Lastly, Home Depot earnings sent HD stock to new 52-week highs, which is sure to suck in even more momentum buyers.

Barring a huge reversal in the housing market, there’s no reason for HD stock to reverse. It’s been a major outperformer this year with solid fundamentals at its back.

And, hey, if nothing else, the market will chase HD’s performance, and that means more multiple expansion ahead.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/home-depot-earnings-hd-stock-valuation/.

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