- Home Depot beat expectations again reporting strong Q4 results.
- With consistent sales growth, OM improvements, and growing returns, they show no signs of slowing down on top and bottom line growth yet.
- With a 17% bump in quarterly dividend and strong fundamentals, Home Depot stock might be a good investment for these volatile markets.
Home Depot (NYSE:HD) fourth-quarter results were impressive. Nearly double-digit revenue growth, a 6.5% net earnings increase, and announcing they’re raising their quarterly dividend by 17%. Combine it with the 3 quarters prior, and fiscal 2016 was an outstanding year for the company.
When looking at a monstrous size company like Home Depot with $88.5 billion in annual sales, investors might wonder why it is trading at nearly 2X sales. Many investors are not going to see this as a growth play, and with the home improvement stores industry average trading lower than Home Depot on most multiple fronts; earnings, sales, book, investors might want to know why it seems like they are paying a premium in comparison.
So why does it seem like Home Depot trades high?
Simply put, Home Depot is outperforming. Even at their size they are growing slightly above the industry average and consistently improving their bottom-line through significant operation margin advances. If we look at fiscal 2016, Home Depot grew sales by 6.4% and net income by 10.5%. Free cash flow grew even more at 15.7%. So if we look at a public comparable to a company like Lowe’s Lowes (NYSE:LOW), Home Depot is going to warrant a higher premium due to their superior growth, operating margin, etc.
Below I’ve created a DCF for Home Depot which uses a 10% discount rate. The terminal growth rate I used was 2.5%. I don’t think the model is overly conservative or aggressive but rather fair. Although Home Depot is seeing consistent growth in revenue and improvements in operating margin, there is always macroeconomic risks that could slow growth as well as the law of large numbers.
As you can see, I have Home Depot’s equity valued at about $142.8 billion, which is about 10% lower than their market cap of $159.3 billion. But keep in mind, this DCF assumes that Home Depot’s FCF growth will slow down over the upcoming years. And given Home Depot’s YoY increases in revenue growth and YoY improvements in operating margin, it is possible that Home Depot can outperform again in the upcoming years.
From a multiples standpoint, Home Depot stock is trading at a PE of 23.3, with the industry average being 22.4. A PE of 23.3 is very fair when competitor Lowe’s is trading at 21.4 and performing significantly worse than Home Depot across top and bottom lines. So in a comparative valuation analysis, Home Depot stock looks as if it is trading fairly.
Source: Market Realist
I believe Home Depot is another example of a great company that is trading at a fair price. As you can see from the chart above, Home Depot’s ROE, ROA, and ROIC have all been rising. ROE is up to 90% for fiscal 2016 due to $7 billion in buybacks, $3 billion in dividends, and the usage of cheap debt to finance capital expenditures versus equity. Their revenue breakdown shows nearly even sales among all product categories, which shows the strength of their diversification. Right now I don’t see Home Depot stock trading as a value or growth play, but they are a strong company trading at a fair price with a solid dividend. And given the volatile markets, this might just be the type of investment investors are seeking for their portfolios.