3 Reasons Home Depot's Stock Could Rise

Even as economic uncertainties start to appear, Home Depot has a lot going for it.

Aug 26, 2014 at 9:30AM

Hd Logo

Source: Home Depot.

Home-improvement giant Home Depot (NYSE:HD) has delivered impressive results for long-term shareholders, not only surviving the housing bust but thriving in its aftermath. Investors have seen their stock hit new all-time record highs for years now, with the big push higher last week in the wake of the second-quarter Home Depot earnings report marking the latest in a long series of successes for the company. Even with some experts doubting how much further the housing recovery can go, there are several reasons to believe that Home Depot stock could push even higher from here. Here are three of them.

1. Housing has continued to be strong, defying falling expectations for future conditions in the industry.

For a long time, investors in Home Depot and other home-improvement retailers have worried that last year's abrupt rise in mortgage rates would snuff out the impressive recovery in the housing market. Yet at least so far, there have been few signs of sluggishness in housing. Just last week, data on housing starts for the month of July showed a 16% jump, with annual rates approaching the 1.1 million level. So far this year, overall housing starts have climbed 22%.

Yet most economists still question whether the numbers are sustainable, emphasizing the fact that much of the new building activity has focused on multi-family housing like apartment buildings. Moreover, the combination of higher rates and climbing prices has pushed measures of affordability to their lowest levels since before the financial crisis. With economists at home-loan government-sponsored enterprise Fannie Mae cutting their forecasts for sales and construction by more than 10%, Home Depot investors are already weighing the possibility of slowing growth in housing. Therefore, if the industry keeps defying those dire predictions, Home Depot could surprise investors as well and send the stock higher.

2. Some of Home Depot's competitors have struggled lately, giving it a chance to poach their customers.

Shld Craftsman

Sears' Craftsman is a big rival in tools, but it's fate is uncertain. Image source: Sears Holdings.

In contrast to Home Depot's upbeat earnings report, competitors have faced some problems. Lowe's (NYSE:LOW) announced its earnings last week, and Home Depot's main rival reduced its sales-growth projections for the year by half a percentage point, in stark contrast to Home Depot's own boost in its earnings forecast. Lowe's said that air-conditioner sales hurt its results, as the summer season has been unusually cool in many parts of the country. Similarly, Sears Holdings (NASDAQ:SHLD) continues to struggle, spinning off its most valuable assets but still leaving the fate of its well-regarded Craftsman line of tools uncertain. And with Home Depot's smaller competitors, which focus on niche areas ranging from hardwood flooring to carpeting and outdoor deck materials, pressure on margins has led to decelerating growth.

Home Depot has a competitive opportunity to take advantage of its competitors' woes and pick up more business. If it can do so, then shares could keep climbing as a result.

3. Home Depot has strong earnings growth potential that can overcome a fairly high valuation.

Home Depot's valuation troubles some conservative investors, with the big jump in share prices over the last week bringing the company's forward earnings multiple for the current fiscal year above 20. In a market that some see as toppy, such high multiples suggest a lot of room to fall if the bull market comes to an end.

Hd Box

Source: Home Depot.

Unlike many of its Dow counterparts, however, Home Depot actually has the growth potential to justify such a valuation. Current expectations for 16% annual growth over the next five years would lead to earnings more than doubling, and that would quickly chop P/E ratios, even if the share price keeps climbing at a modest rate. Fears about housing won't necessarily get in Home Depot's way, as the company managed to grow even before home prices started recovering.

Home Depot has done a good job throughout the past decade in identifying areas to expand its business, and its execution has been nearly flawless even through one of the most troubled times in the nation's economic history. Even if conditions become slightly less favorable, Home Depot has the opportunity to capitalize on its past success and continue producing strong results for its shareholders.

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Dan Caplinger 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.

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