Home Depot’s 3 Part Recipe For Success

This is a different kind of stool, one that pertains to Home Depot’s future and potentially your investment portfolio.

Jul 25, 2014 at 9:00AM
Home Depot

HomeDepot.com

Home Depot (NYSE:HD) launched its interconnected retail strategy early last year. Now it's time to see if it has been effective, and if it's likely to aid Home Depot's growth going forward.

Interconnected Retail
The seat of Home Depot's three-legged stool is Interconnected Retail. The three legs holding up the seat are customer service; product authority; and disciplined capital allocation, productivity, and efficiency. 

Interconnected Retail is intended to connect the three key initiatives listed above (three legs of the stool) to build a seamless and competitive experience platform across all commerce channels.  

Customer service
Customer service is what Home Depot is most passionate about. The ultimate goal is to build an emotional relationship with customers. 

If you have walked into a Home Depot on the weekend recently, then you might have noticed many more smiling employees saying hello to you. This is a nice improvement, but try visiting during the week during off-peak hours. You will not receive the same greeting. In order to be great, Home Depot must offer this excellent customer service at all times. However, numbers don't lie, and Home Depot's Net Promoter Score has consistently improved since 2007.   

The easiest way to explain the Net Promoter Score is that it's based on the number of customers who would recommend shopping at a specific retailer. Home Depot sees this as important information since it used the Net Promoter Score as part of its 2014 Oppenheimer Consumer Conference presentation.

In 2007, Home Depot sported a Net Promoter Score of 50%. Without any annual declines, that score has improved to 73% in the first quarter of 2014.

Additionally, Home Depot has gained traction with its Pro Xtra loyalty program, which now has more than 1.5 million enrollees. Pro Xtra provides customers with discounts on useful business services, exclusive product offers, and streamlined payment and receipt tracking tools. Pro Xtra member shopping frequency, ticket size, and size of basket all increased in the first quarter.

Customer service and loyalty are important, but they're still just one leg of the three-legged stool. In order to drive new (and repeat) customers to its stores, Home Depot also needs to sell highly appealing merchandise.

Product authority
Home Depot is focused on product innovation, assortment, and value. Examples include expanding LED light bulbs from Cree, introducing a gas-powered lawn mower from Toro that folds up in your garage and saves 70% storage space, and adding KitchenAid to its appliance assortment.

Home Depot deserves a healthy check mark in this category. Now let's move on to the matter shareholders care about most.

Disciplined capital allocation, productivity, and efficiency
In order to build shareholder value via higher returns on invested capital and total value returned to shareholders, Home Depot will focus on continuous store and supply chain operational improvements. Home Depot hasn't provided many details on how it will improve its supply chain, but there are some important numbers you should know.  

Home Depot's annual dividend per share has increased from $0.95 in 2010 to $1.56 in 2013, and it's forecast to reach $1.88 this year. Home Depot's annual dividend yield is currently 2.3%, considerably higher than the 1.1% yield for S&P Retail ETF and slightly higher than Lowe's (NYSE:LOW) at 2%.

In the first quarter, Home Depot generated $2.6 billion in cash flow from operations. With that, it spent $1.25 billion on share buybacks, $646 million on dividends, and $287 million on capital expenditures. The return on invested capital came in at 21.2% versus 17.7% in the year-ago quarter.

Cash flow from operations provides Home Depot with a significant source of liquidity. This is very important for investors in a time of uncertain economic growth for the United States. If the economy falters, then you want to rely on a company that will still take care of its shareholders. While Home Depot and Lowe's both take care of their shareholders, Home Depot generates more cash flow:

HD Free Cash Flow (Annual) Chart

Home Depot Free Cash Flow (Annual) data by YCharts

And it's generating its cash flow at a faster pace:

HD Free Cash Flow (Annual) Chart

Home Depot Free Cash Flow (Annual) data by YCharts

When it comes to efficiency, the same story unfolds for return on invested capital:

LOW Return on Invested Capital (Annual) Chart

Lowe's Return on Invested Capital (Annual) data by YCharts

Once again, Home Depot is growing its ROIC at a faster pace:

LOW Return on Invested Capital (Annual) Chart

Lowe's Return on Invested Capital (Annual) data by YCharts

The bottom line
The first two of Home Depot's three-legged stool initiatives should lead to maximized top-line and comps growth. The third leg of that stool (based primarily on shareholder returns) looks very sturdy. This is imperative in one of the most uncertain and unpredictable economic times in history.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

 

Dan Moskowitz 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 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers