Here's Why The Home Depot Inc. Deserves its Place on the Dow

The Dow Jones Industrial Average (DJINDICES: ^DJI  ) has been America's most-watched market index for decades, despite -- or perhaps because -- of its narrow focus on a mere 30 stocks. Where other indices might track 500, or 2,000, or even 5,000 different stocks, the Dow's steady focus on 30 business bellwethers has made it both easier to understand and easier to dismiss as a relic of simpler times. But as long as the Dow remains front and center in every day-to-day market analysis, it and its component companies will remain the most important barometers of American markets.

Source: David Neubert via Flickr.

That's why it's important to understand not only the Dow, but its components as well. What do they do? What do they represent on the Dow, and why do they matter to the American economy? Where have they come from and where might they be heading in the future? Today we'll dig into the details of Home Depot (NYSE: HD  ) to find answers to these questions and more, so that we can understand not just what moves the Dow, but why.

Home Depot at a glance

  • Founded: June 21, 1978.
  • Joined the Dow: Nov. 1, 1999.
  • Current Dow weighting: 3.1% (16th of 30 components).
  • Replaced: Sears to diversify retail representation.
  • Sector represented: Retail (home improvement).
  • Rank (by revenue) among all retail stocks:
    • o 5th (National Retail Federation, by U.S. retail sales)
    • o 6th (National Retail Federation, by worldwide retail sales)
    • o 2nd (Fortune 500, Specialty Retail)
    • o 1st (Forbes Global 2000, Home Improvement Retail)

Home Depot is one of the Dow's youngest components, but it's also been one of the fastest-growing. Since opening its first two locations in Georgia in 1979, Home Depot has become an international operator of more than 2,200 massive stores that generate nearly $80 billion in annual revenue. Of all companies on the Fortune 500 with greater annual revenues (Home Depot ranked 33rd overall for 2014), only two -- Express Scripts and Costco were founded after Home Depot, and only two others were founded within the five-year period before Home Depot's establishment.

As it has grown, Home Depot has transformed the way America handles its home-improvement needs, which were previously served by a large number of small specialty outlets handling only one or two aspects of home construction and design. By bringing virtually every aspect of home improvement, from lumber to lighting, under one roof, Home Depot has become not only the first destination for millions of remodelers, but also the closest thing America has to a single corporate representative for the multitrillion-dollar housing market.

Home Depot by the numbers

HD Chart

HD data by YCharts.

  • Ten-year share price growth: 134.6%
  • Ten-year dividend growth: 452.9%
  • Total return (with dividends reinvested): 200.3%
  • Average P/E over the past decade: 17.2 
  • Current P/E premium over average P/E: 18.6%

[HD Revenue (TTM) Chart

HD Revenue (TTM) data by YCharts.

  • Annualized revenue growth (past five years): 3.3%
  • Annualized EPS growth (past five years): 23.2%
  • Annualized free cash flow growth (past five years): 9.2%
  • Change in profit margins (past five years): 102.4%

Home Depot's top line might be dependent on the health of the housing industry, but that has hardly kept the company from putting together an impressive stretch of outsized earnings-per-share growth. And even this modest annual sales growth looks quite strong when compared to the actual progress of the housing industry over the past five years:

HD Revenue (TTM) Chart

HD Revenue (TTM) data by YCharts.

Keep in mind that sales of existing homes are more important to Home Depot than are housing starts: Remodeling is common before a sale and there are roughly five times as many existing homes sold as housing starts, even after a multiyear decline in the former and a major surge in the latter. But Home Depot has continued to reward shareholders handsomely by controlling costs and expanding its margins, and its leadership team has plans to sustain this trend. Recent strategic initiatives include large investments in supply chain and e-commerce technology improvements; the construction of three new fulfillment centers for the western, southeastern, and northeastern regions; and development of a same-day delivery service.

Over the long term, Home Depot hopes these strategies will produce an operating margin of roughly 13% (it was 11.8% in the latest reported quarter on a trailing 12-month basis) and return on invested capital of about 27% (up from 19.5% in the latest quarter). Wall Street is similarly optimistic, as it expects Home Depot to outperform the home-improvement sector by posting annualized EPS growth of 16.3% over the next five years, against 13.2% for the industry as a whole. If the Dow meant to select the best of the retail sector, it chose well with Home Depot, which has been better than both its sector and the sector it symbolizes for many years.

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