Can Home Depot Trounce the Dow Again in 2013?

Now that 2012's nearly in the rearview mirror, investors are beginning to sift through the market for the best stocks of the upcoming year. The future is plagued with uncertainty, but that has always been the case, and it's never stopped us from seeking out long-term values. One way to find those values is to look for companies with a long history of success. The Dow Jones Industrial Average (DJINDICES: ^DJI  ) contains many such companies, but some are better investments than others.

Today we'll be taking a look at Home Depot (NYSE: HD  ) , a Dow component since 1999, to see whether its preparations for 2013 -- and analyst attitudes -- indicate a stock with growth potential, or one to avoid.

First-half recap
Since the start of the year, Home Depot has been one of the Dow's best stocks. In several respects, its growth is well-deserved, as the company has substantially improved most (but not all) of its key trailing-12-month metrics since the third quarter of 2011:

HD Revenue TTM Chart

HD Revenue TTM data by YCharts.

Although Home Depot may be one of the more highly valued stocks on the Dow, it's also granted one of the most optimistic forward expectations by the large group of analysts tracking its every move:

Market Cap

$91.5 billion

P/E and Forward P/E

21.8 and 16.6

Price to Free Cash Flow

17.7 

2013 Projected Growth Rate

14.1%

2013 Earnings Per Share Estimates

$3.47

5-Year Annualized Projected Growth Rate

16.3% 

Buy/Hold/Sell Ratings

17/13/0

Average Price Target

$67.73

Sources: Yahoo! Finance and Morningstar.

What the numbers don't tell you
The obvious driver of this optimism, as well as Home Depot's prior-year gains, is clearly the perception of a rebound in the housing market. The Case-Shiller Home Price Index has been rising throughout the year, with a composite of 20 metro-region prices leading the national index toward what appears to be a positive end to the past two years:

Case-Shiller Home Price Index: National Chart

Case-Shiller Home Price Index: National data by YCharts.

Additionally, both existing home sales and pending sales, the latter which measures contract activity, have grown strongly throughout 2012, pulling the single-family home sales total up as well:

US Existing Home Sales Chart

U.S. Existing Home Sales data by YCharts.

Home Depot -- and, similarly, Lowe's (NYSE: LOW  ) -- benefit on both sides of this spectrum. A new home needs to be built out of something, obviously, and even large homebuilders will need to find specific parts and materials at their nearest home-improvement warehouse. Existing homes will likely require renovation, either before or after their sale, and the homebuyers in these cases are almost guaranteed to need something from a home-improvement warehouse. The Leading Indicator of Remodeling Activity, or LIRA, compiled by Harvard University, projects a large uptick in renovations in 2013. That increase should break through stagnant remodeling volume that's hovered between $110 billion and $115 billion per quarter for over two years.

So far, homebuilders have seen the strongest surges of the various construction subsectors, but their underlying financial performances have been a bit wobbly. Although PulteGroup (NYSE: PHM  ) and Hovanian (NYSE: HOV  ) are both multibaggers this year, Hovanian has yet to regain either profitability or free cash flow, and Pulte's free cash flow remains below its levels of two years ago. On the other hand, Home Depot has grown both free cash flow and net income in the same period by enviable levels, although there appears to be a bit of flatlining in its latest quarter.

If anticipated remodeling really meets the high levels LIRA expects next year, then analyst estimates for 14% growth might prove conservative. By the second quarter of 2013, LIRA anticipates a 17% year-over-year increase. There's no projection beyond this point, but that is quite the improvement. Since Home Depot has captured more of the gains from remodeling activity than Lowe's over the past two years (judging by their respective net income and free cash flow growth rates), it should be the one to get the lion's share of 2013's projects as well.

As we head into a new year, there are potentially a dozen housing-related stocks that could become the best stock of 2013. The Fool's chief investment officer doesn't think that it'll come from that sector, because he's found one well-positioned niche leader in another resurgent part of the economy that's set to explode next year. Find out more about our "Top Stock for 2013" in our all-new, exclusive free report. Click here to get the information you need, at no cost.


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