Is It Time to Start Investing in Home Depot?

Home Depot has been out of favor with the market recently but has strong fundamentals working in its favor.

May 27, 2014 at 12:33PM

Home Depot (NYSE:HD) released first-quarter earnings on May 20 and its shares fell over 1% in pre-market trading as revenue missed expectations and analysts voiced concern over the housing market on which Home Depot relies heavily.

Shares of the company have recently lagged those of competitor Lowe's (NYSE:LOW) as well as the broader market. It could be time to start buying.

HD Total Return Price Chart

HD Total Return Price data by YCharts

First-quarter earnings at a glance
Analysts were expecting Home Depot to report revenue of $19.95 billion and earnings per share of $0.99. The company actually reported revenue of $19.7 billion and earnings per share of $1.00, or $0.96 excluding a positive effect of $0.04 per share from the sale of an equity holding in HD Supply. 

Chairman and CEO Frank Blake commented, "The first quarter was affected by a slow start to the spring selling season. But we had solid results in non-weather affected markets and expect our sales for the year to grow in line with the guidance we previously provided."

Home Depot also provided an updated estimate for the fiscal year, which included sales growth of 4.8% and earnings-per-share growth of 17.6% to $4.42 per share.

Underlying factors
As Mr. Blake commented, severe weather in the winter and early spring contributed to the revenue miss, as Home Depot relies on home builders and contractors for many of its sales.

Along with the weather, many analysts are concerned about the recovery in the housing market, and this caused the company's shares to fall. The National Association of Home Builders Housing Market Index took an unexpected decline in May, and recent housing-starts data has not been overly impressive.

The housing market has been negatively affected by higher home prices as well as mortgage rates that surged at the end of 2013.

Home Depot's value
The housing market's potentially slowing recovery is clearly a problem for Home Depot. The recession is still vivid in the minds of homebuilders and consumers, which makes many decisions very emotional at this stage. However, over the long term, we would expect to see the market stabilize or become less volatile and this would help stabilize revenues and earnings for Home Depot.

Volatility has created this opportunity to buy Home Depot at fairly attractive prices on its recent lag from the market. Currently Home Depot shares are selling at 20.7 times earnings, lower than competitor Lowe's at 21.5 times earnings and higher than the market at 18 times.

However, over the last five years, Home Depot has averaged revenue and earnings-per-share growth of over 3.5% and 19.1%, respectively. These figures easily trump Lowe's 2.5% and 12.1% annual revenue and earnings-per-share growth averages over the same period.

Home Depot's stellar earnings-per-share growth has been fueled by a widening margin over the last five years, as its current net margin stands at 6.8% compared to 4% in 2010. This margin widening has helped grow earnings by 15% per year over the last five years; this shows us that earnings per share have also been influenced by the company's commitment to putting its cash flow to work by repurchasing shares on the open market. The company has used $16 billion in cash to repurchase its shares in the last three years. 

Bottom line 
Short-term fluctuations in the housing market have created volatility in Home Depot's shares, which could help us investors obtain large amounts of long-term value. The company has fallen out of favor in the market lately, but the numbers are impressive. 

Using management's expectations of earnings-per-share growth of 17.6% to $4.42 per share, we find that Home Depot's shares are currently trading at around 17.6 times future earnings. This figure is very cheap compared to many other companies that are growing their earnings per share at such high rates.

Growth in earnings per share stems from widening margins that have helped earnings growth outpace revenue growth as well as the company's share-buyback program. The share-buyback plan as a means for earnings-per-share growth should not be considered troublesome to investors as the company has stable and growing revenues and earnings, along with the stable cash flow to finance such programs. 

Share buybacks will increase investors' pieces of the pie in regard to future earnings, which will help send Home Depot's shares higher as the housing market stabilizes. In the meantime, investors can happily collect a handsome dividend that currently yields around 2.5%. 

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Jacob Meredith and clients of Appalachian Capital Group, LLC have no positions in any stocks mentioned. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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