Home Depot: A building block for the portfolio.
Opdateret: 7. aug.
Home Depot has been a good investment, delivering significant value to shareholders. Over the last decade, the share has grown at a compounded annual growth rate of around 14.5%, while the number of shares outstanding has been reduced by 28%. In the same decade, the dividend has increased from $1,64 to $8,36. The question is whether Home Depot will be a good investment for the future, based on its past performance. It is something that I will investigate in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in Home Depot. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors to Home Depot either. Thus, I have no personal stake in Home Depot. If you want to buy shares (or fractional shares) in Home Depot, you can do so at eToro.
Home Depot was founded in Georgia, USA in 1948 and has since grown to become the world’s largest home improvement retailer based on net sales. Home Depot sells a wide assortment of building materials, home improvement products, lawn and garden products, decor products, and maintenance repair and operations products, totalingapproximately 30,000–40,000 different items. They also offer services such as home improvement installations and tool and equipment rentals. Home Depot has 2,322 stores located throughout the United States (including Puerto Rico, the U.S. Virgin Islands, and Guam), Canada, and Mexico. Home Depot serves two customer groups: DIY customers and professional customers. Their customers buy their products both online and in stores. In fact, 60% of their sales come from customers who shop with them through both channels. This success has made Home Depot the fifth largest e-commerce player in North America, across all segments of retail. Home Depot has a clear strategy in providing the best customer experience, extending their position as a low-cost provider, and being the most efficient investor of capital in their sector. Home Depot has a large brand moat as it is one of the most iconic and valuable brands in world.
Their CEO is Ted Decker. He joined Home Depot in 2000 and held various positions in the company before becoming the CEO in 2022. Prior to joining Home Depot, he held various positions in companies such as Kimberly-Clark Corp, Scott Paper Co., and PNC Bank. He holds a bachelor’s degree in English from The College of William and Mary and a master’s degree in Business Administration from Carnegie Mellon University. Throughout his more than twenty years and various roles at Home Depot, Ted Decker has developed a deep knowledge of all areas of the business. He has been credited withcreating a seamless, interconnected shopping experience for professional and do-it-yourself (DIY) customers, while integrating the online and in-store realms to provide better service to customers. Ted Decker has only been the CEO in a challenging year of 2022, so it is impossible to judge him based on his results. However, he does have vast experience in the company and a clear strategy on how Home Depot will grow moving forward. Furthermore, according to Comparably, he has an employee rating that places him in the top 20% of similar-sized companies, which is also commendable. Hence, although he has only been CEO for a short time, there may be some uncertainties regarding his management abilities. However, I still have confidence that he has the necessary experience to lead Home Depot in the future.
I believe that Home Depot has a strong brand moat. However, I believe that there are some uncertainties regarding the management. Now let us investigate the numbers to see, if Home Depot does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on investment capital, also known as ROIC. We require a 10-year history, with all the figures exceeding 10% for each year. These numbers are certainly encouraging, as Home Depot has consistently delivered a return on invested capital (ROIC) well above 10% every year for the past ten years. Furthermore, the Return on Invested Capital (ROIC) has been above 20% every year since 2015. Few companies have delivered a return on invested capital (ROIC) like Home Depot. It is encouraging to see that Home Depot managed to achieve their second-highest ROIC in the last ten years in 2022, despite the challenges of the year. These numbers are impressive, and as an investor, I would be delighted to see such strong figures.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. The initial thought on these numbers is that they are underwhelming. Equity has decreased almost every year in the past decade. The reason for this is that Home Depot, like many other companies, has taken advantage of low interest rates and has used debt to buy back shares. It is unlikely that this will continue, as interest rates have increased. I will leave it up to you to decide whether you like that strategy or not, as there are both advantages and disadvantages.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Home Depot has steadily increased its free cash flow every year until 2022. However, 2022 was a challenging year for most companies due to surging inflation. And it is also worth noting that Home Depot delivered the second highest free cash flow in the last ten years in 2022. Levered free cash flow margin has remained stable over the years but reached its lowest point in 2022, as did the free cash flow yield.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings.Doing the calculation on Home Depot, I can see that Home Depot has 2,23 years of earnings in debt. It is below the 3-year requirement, so debt is not something that I worry about.
Based on my findings so far, I believe that Home Depot is an interesting company. However, no investment is without risk, and Home Depot also has its share of risks. One risk is competition. For most retailers, competition poses a risk, and Home Depot is no exception. Home Depot operates in a highly competitive, fragmented, and ever-changing industry.Thus, they face competition from a variety of retailers, suppliers, service providers, distributors, and manufacturers. These competitors range from traditional brick-and-mortar retailers to multichannel and exclusively online retailers. Another risk is macroeconomics. If we are facing a prolonged recession in North America, it will have an impact onHome Depot. Home Depot had a difficult 2008–2009, with sales dropping, which in turn affected earnings per share, causing a decline of approximately 24%. We are already seeing a slowdown in the housing market in the United States, which has resulted in fewer people undertaking DIY projects. At the same time, we see companies pausing large-scale projects or shifting towards smaller, lower-cost products. If these trends continue for a longer period, they will affect Home Depot’s results. Labor needs and labor costs. One of Home Depot’s strategic focuses is customer service. Thus, Home Depot needs to attract, develop, and retain a large number of highly qualified employees. Currently, Home Depot employs 471,600people, and since 2021, we have seen a significant increase in wage growth. If this wage inflation continues, it will be difficult for Home Depot to control costs while maintaining the high level of customer service that is one of their strategic pillars. Furthermore, the unemployment rate is still low, which may make it difficult to attract new skilled employees.
Home Depot also has a lot of potential for growth. One growth catalyst is the sizeable addressable market. The home improvement retail market has continued to grow in recent years. Thus, Home Depot estimated that its total addressable market is worth $950 billion. It means that Home Depot represents only a relatively small portion of a large and highly fragmented market, as it currently holds approximately 17% of the market share. An attractive customer base. Home Depot believes that its customer base is one of the most attractive in any sector of the economy. Home Depot’s customer base has higher than average incomes, and 80% of their customers own their homes, which compares to a home ownership rate of 66% across the United States. And their home, which is the most valuable asset for most of their customer base, has appreciated by 40% since 2019. And while we may see weaker short-term price appreciation on houses, the long-term price appreciation should increase over time. Once this happens, it will drive demand for home improvement. Furthermore, homes continue to age, with 50% of the housing stock being more than 40 years old. This indicates a greater need for home improvement. New stores. Home Depot’s stores have approximately 1.7 billion transactions a year. Thus, most customers still prefer to go to physical stores. Home Depot sees new stores as an opportunity to increase sales and intends to open around 80 new stores within the next five years. These stores will be located in areas that have experienced population growth or in locations where it makes sense to alleviate some pressure on existing high-volume stores.
I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 15.53, which is the one from 2022. I chose an estimated future EPS growth rate of 8% (management expects to grow EPS by mid-to-high single digits), an estimated future PE of 16 (which is double the growth rate, as the historical PE for Home Depot has been higher), andwe already have a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $132,60, and we want to have a margin of safety of 50%, so we will divide it by 2. This meansthat we want to buy Home Depot at a price of $66.30 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The Operating Cash Flow last year was $14,615 The capital expenditures were $3,119. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn’t find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use $2,183 in our further calculations. The tax provision was $5,372. We have 1,020 outstanding shares. Hence, the calculation will be as follows: (14.615–2.183 + 5.372) / 1.020 x 10 = $174.55 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Home Depot’s Free Cash Flow Per Share at $11.28 and a growth rate of 8%, if you want your purchase to be paid back in 8 years, the Payback Time price is $129.58.
Home Depot is a great company that has delivered significant value for shareholders over the past decade. The company has a strong competitive advantage and a clear strategy for future growth. There are some uncertainties regarding management, as the CEO has only been in the position for just over a year. However, he does have vast experience in the company, meaning he has the skills to propel Home Depot forward. There are some concerns regarding macroeconomics and cost control, but I believe these are short-term challenges. Competition will always pose a risk for a retailer, but Home Depot has a strong competitive advantage, which should give them a solid edge. The addressable market is already large and is expected to grow even larger. Thus, Home Depot should have a long runway for growth. I also believe that opening new stores will boost both the top and bottom line moving forward, as these stores will further enhanceconvenience for customers. Actually, management believes that the real estate footprint of Home Depot is nearly impossible for competitors to replicate, which further enhances the company’s competitive advantage. I doubt that Home Depot will ever reach the Ten Cap price of $174.55 but if it does, I will be buying shares.
I also write exclusive posts on Medium. If you want to read my posts, you can join Medium by clicking here. It costs $5 a month, but it will allow you to access all my posts as well as everything else on Medium, which is highly recommendable.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how I do it, you can read this post.
I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.
Some of the greatest investors in the world believe in karma, and to receive, you will have to give (Warren Buffett and Mohnish Pabrai are great examples). If you appreciated my analysis and want to get some good karma, I would kindly ask you to donate a bit to 10.000 dogs. They rescue street dogs in Thailand by giving them food, medicine and vet care. If you have a little to spare, please donate here. Even a little will make a huge difference to save these wonderful animals. Thank you.