If you've ever purchased a home, then you understand why the dynamics of the housing market are critical to the success of Home Depot (NYSE:HD). This is why, assuming the company's economic forecasts are accurate, shareholders in the retailer have reason to be optimistic.

The big issue in the housing market right now is supply. That is, there isn't enough of it.

The housing market is said to be in balance when the supply of listed homes equals six months' worth of sales. If the supply exceeds that -- if, say, the current supply is equal to seven months' worth of sales -- then home prices will likely fall. But if supply is less than the six-month threshold, then the opposite holds true and prices would typically rise.

Where are we now? As of February, there were an estimated 2 million houses listed for sale. Meanwhile, an average of 385,000 homes sold in each of the previous six months. This equates to a current supply of 5.2 months' worth of sales (2 million divided by 385,000).


If you've been wondering why home prices have been shooting higher despite the ongoing economic malaise, this is it. Since February 2013, they've jumped by double digits on a year-over-year basis in 11 consecutive months, increasing most recently by 13.2% in January.

To get back to Home Depot, in turn, this is great for the massive home improvement retailer because home prices are one of its principal business drivers. As CFO Carol Tome noted on the latest conference call (emphasis added):

As we look at the macro, we think housing will be a contributor to our growth next year of about 200 basis points. We think it contributed about 250 basis points in 2013. Biggest driver is home price appreciation. And last year, as you know, home prices were up double digit. We're not forecasting that in 2014. We think it'll be up around 6%. Now home prices have 21% to go before they return to peak, so perhaps it's a conservative outlook, but we think it's a realistic outlook to build a plan on.

For Home Depot's shareholders this means two things. First, if these predictions pan out, then the company will have the ammunition necessary to increase its dividend, as its executives have promised. And second, it means that the retailer's sales, earnings, and thus share price should similarly respond in kind.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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