Home Depot: Constructing Dividends


After the burst of the housing bubble, perhaps the most logical industry to grow would be housing improvement, as countless millions of homeowners tried to re-coup some of the tens of thousands of dollars trimmed from their property as the sub-prime lending practice imploded on the American economy.  If the example of Home Depot represents the broader trend in the industry, and there's little reason to think it wouldn't given their fantastic market share, then investors who hold Home Depot stock should hope for another housing crisis -- provided they rent rather than own, of course.  Home Depot has shot up by 150% in the past five years, offering a rate of return that few other investments in all the world can hope to match.  After turning over a 26% growth in dividends, investors may wonder whether Home Depot has tapped out, or whether there's more building left to be done.

Against The Field

How well has Home Depot (HD on the NYSE, trading for $113.03 a share) done against the field?  The raw numbers on their own are impressive, but compare them to some other giants on the market, even those having good years, and the picture grows rosier still.  Their double-digit growth is twice as high as the standard growth stocks like Proctor and Gamble or General Electric since 2010.  Even Apple, the most popular stock on the market (their 64 million shares traded per day is nearly twice as many as the next two corporations combined) can't return such impressive numbers on a year-in, year-out basis.  You have to go back to 2009 to find the last time that home Depot didn't pay out a dividend hike to investors, a time when just about every other company under the sun struggled on the market.  Yet fantastic dividend payout growth offers less optimism, if you can believe it, than their cash flow towards stock buybacks.  Home Depot spent $3 on stock buyback for every $1 they spent on dividends payout for investors.  The message here could hardly be clearer: Home Depot's debt is so fantastic that it currently sits at the ratio of three times more valuable than cash.  And why not?  Home Depot currently earns a staggering 25% return on invested capital, meaning that (wait for it) they're better at handling money than even the best mutual fund managers.  While that number will certainly dip in the next few years, it paints a picture of a company with fantastic stability and a vision for the future.  You can hardly say that about many other Fortune 500 companies -- look no further than McDonalds, who hasn't had any net growth in the past three years and doesn't seem like they really care at all.

Growing Pains, Or Lack Thereof

There's no small irony that a company grown rich by selling nails and plywood wants to build up at a slower rate than their competitors.  After watching some of the big-box competition fall flat on its face by over-saturating the market (we're looking at you, Wal-Mart), Home Depot hasn't decided to spread their mega-warehouses out over every city with more than one traffic light.  Instead, Home Depot plans to open just six -- not six dozen or six hundred, mind you, but six -- new stores this year.  Their 2300 facilities in operation have been pulling their weight and then some, meaning that a .3% growth rate suits them perfectly fine.  Home Depot isn't threatened by many of the same factors that are killing the big box stores.  Amazon struggles to sell home improvement products because of the very tangible desire by customers to see a sink or a marble fireplace in person prior to purchase.  With so little cash going towards new acquisitions or developments, a lot more ends up in the pockets of both management and investors.  Said cash appers stable, furthermore, as the company hasn't had dividend payouts rise above half of gross profits since 2010 and the recovery from the recession.  Currently holding at around 40%, management has stated they want dividend payouts to rise to half of gross profits overall, indicating more payout even if the stock growth slows by a hair due to lesser payout. 

Projections Corrections

The good news from Home Depot should be tempered by realistic expectations.  While their 4% sales growth is still far ahead of the average, it's below the 5% projections and the 7% gain experienced in 2013 and 2014.  That's not to suggest that Home Depot is on the decline, but that investors need to jump aboard quickly in order to ride out the surge while the company continues to dominate the market.  With a payout covered by cash flow several times over and a certainty of strong performance through 2016, you could hardly ask for more from an investment engine than Home Depot.

  • The Takeaway: there's no portfolio that shouldn't contain Home Depot as a major lynchpin of growth.  Investors may not consider it a value buy, at least not compared to the asking price five years ago, but the room left for improvement makes it tremendously valuable in and of itself.  Anyone frustrated with poor performance from major retailers can use Home Depot as a hedge against slow consumer spending, especially if one retailer's holiday performance doesn't quite stack up to expectations.
  • When should you consider selling?  Setting aside personal needs, Home Depot looks like a solid choice for at least 24 months.  It's the ultimate invest-and-forget-about-it stock that's going to enjoy good growth as the housing market continues its recovery.  Given the strong year-to-year growth, there's opportunity for short-term investment, but little reason to think that you won't regret the decision in the following months.

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