The home improvement market hasn't yet recovered from the 2009 housing crisis -- but Home Depot's (HD -0.60%) shares are a different story: The stock is up 300% over the last five years, compared to a 71% gain in the S&P 500.
With shares heading higher still ahead of Home Depot's third-quarter earnings announcement this week, investors are clearly optimistic about the upcoming results. But can the retailer live up to the ultra-high expectations? Here are the key improvements shareholders will want to see.
Rising customer traffic and spending
Market-thumping sales growth has been the main engine of Home Depot's surging business gains. Most recently, comparable-store sales rose by 6% through the first half of 2015, outpacing rival Lowe's (LOW 0.22%) 5% growth over the same time. Home Depot also managed 5% comps in 2014 and 7% comps in 2013, compared to Lowe's 4% and 5% gains, respectively.
Yet the comps number alone doesn't convey the real scale of Home Depot's recent operating success. Last quarter, customer traffic hit a record and the retailer booked its highest average guest spending since 2006, which was a high-water mark for the industry. "All three of our U.S. divisions exceeded their sales plan with mid to high-single digit comps and all of our 19 regions and top 40 markets also posted positive comps in the quarter," CEO Craig Menear said in a conference call.
To keep that momentum going, Home Depot will need to post customer traffic and average spending growth each in the neighborhood of 2%, yielding an overall comps gain of around 4% in the third quarter.
E-commerce wins
Online spending is growing much faster than the retailing industry, which is putting traditional stores in a tough position. With their high cost structure and limited inventories, these bricks-and-mortar giants have trouble competing against low priced e-commerce specialists. But Home Depot has so far been one of the few exceptions to this trend: Its e-commerce sales jumped 25% higher last quarter and now make up over 5% of the business -- compared to less than 3% for retailers like Target and Costco.
Home depot's multi-channel retailing strategy. Source: Home Depot investor presentation.
Management is aiming to push that number higher, which is why it recently opened its third distribution facility dedicated to online orders. The two million square foot structure is an expensive bet on a changing business model. But management believes the company "must continue to take risks and adapt" as shopping patterns shift online.
Growing capital efficiency
Operating improvements like these aren't much use to shareholders unless management can efficiently turn them into tangible financial gains. That's where Home Depot has really excelled lately. Its return on invested capital just set a new all-time high of 25%. And, at 70%, its return on equity is one of the best in the entire stock market.
HD Return on Invested Capital (TTM) data by YCharts
Those efficiency gains have powered outstanding growth in cash returns to shareholders. The company expects to spend $7 billion on stock buybacks in 2015 while delivering a significantly higher dividend than last year.
In fact, management has a stated goal of returning 50% of earnings to investors through dividend payments. The payout is currently below that target. Meanwhile, earnings are on track to climb by as much as 14% in 2015. So, if Home Depot can continue its growth streak through the second half of the year, investors might get a dividend raise of around 20%, on top of the 26% and 21% boosts of the prior two years.
