Dividend Report Card: Home Depot

In the dividend report card series, we analyze financial metrics to begin answering the following questions about a company's dividend:

  1. Over time, has this company steadily increased its payouts?
  2. How sustainable is the dividend?
  3. Does the company have room to further increase the dividend?

For a full explanation of each category, click here for a tutorial.

Today's pupil is Home Depot (NYSE: HD  ) , which has a 3.3% yield.

Dividend history

Metric

5-Year Annualized Growth Rate

Dividend per share

20.0%

Diluted earnings per share

(6.5%)

Source: Capital IQ, as of July 28, 2010.

Over the past few years, Home Depot has transitioned -- I would say smartly -- from a high-growth company with an eye on store expansion under former CEO Bob Nardelli to a mature growth company with a focus on efficiency, modest growth, and cash generation under Frank Blake. This has been welcome news for income-minded investors. In July 2005, for instance, Home Depot yielded less than 1%. If Home Depot is to continue raising its dividend at an above-average rate over the next five years, however, earnings growth will need to pick up once again.

Sustainability

 Metric

Trailing 12 Months

Final Grade
Weighting

Report Card Score
(out of 5)

Interest coverage

7.7 times

10%

4

EPS payout ratio

53.7%

10%

4

FCFE payout ratio

40.9%

30%

5

Source: Capital IQ, as of July 28, 2010.

These are all encouraging signs that the current dividend level is sustainable. One caveat to keep in mind when you're looking at a retailer's balance sheet is that, in most cases, the company's leases are considered operating leases and so aren't listed on the balance sheet as debt. However, savvy investors will want to convert those operating leases to debt to get a clearer picture of the company's actual obligations. After making these adjustments, Home Depot scores a 4 rather than a 5.

Growth

Metric 

Trailing 12 Months

Final Grade
Weighting

Report Card Score
(out of 5)

EPS payout ratio

53.7%

10%

3

FCFE payout ratio

40.9%

20%

4

Sustainable growth rate

7.0%

10%

3

Even though growth has slowed at Home Depot, it still generates a ton of free cash flow, which points to an ability to grow the dividend slowly but steadily in the coming years. There's no guarantee of this, of course, but if the housing and consumer spending recovery remain stable, I see no reason why Home Depot couldn't further increase its dividend in the coming years.

Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against direct competitors'. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

Company

Dividend Yield

Lowe's (NYSE: LOW  )

2.1%

Tractor Supply (Nasdaq: TSCO  )

0.8%

Sears Holdings (Nasdaq: SHLD  )

0.0%

Home Depot's 3.3% yield certainly stands out relative to competitors. This fact, combined with its limited growth opportunities implies that Home Depot's dividend is unlikely to increase at another 20% annualized clip over the next five years -- 5%-7% annualized would be more likely.

Pencils down!
With all the numbers in, here's how Home Depot's dividend scored:

Weighting

Category

Final Grade

10%

History

5

 

Sustainability

 

10%

Interest Coverage

4

10%

EPS Payout Ratio

4

30%

FCFE Payout Ratio

5

 

Growth

 

10%

EPS Payout Ratio

3

20%

FCFE Payout Ratio

4

10%

Sustainable growth

3

100%

Total Score (Out of 5)

4.2

 

Final Grade

B+

A "B+" is a great grade for a company that was directly affected by both the housing crash and the decline in consumer spending. Blake has done a tremendous job since taking over the CEO role in 2007 by scaling back capital expenditures and returning focus to improving existing stores. Home Depot offers a nice yield for investors looking to add some consumer exposure to their income-focused portfolio.

Fool analyst Todd Wenning owns shares of Home Depot. Home Depot and Lowe's are Motley Fool Inside Value recommendations. Motley Fool Options has recommended writing puts on Lowe's. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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