Stocks Fools Love
Home Depot

By Donna Howell (TMF News)
February 8, 2000

Trading at $59 1/2 as of February 7, 2000

Home Depot is where the heart is.

Do-it-yourself investors who try a money-saving house project may first encounter the store rather than the stock. It's a place of packed parking lots, reasonable prices, and doo-dads for every conceivable constructive purpose. Reportedly a typical Home Depot sells about $850,000 worth of those doo-dads every week.

This is a fun store where you can also buy an inexpensive bouquet of fresh flowers, order a decent hot dog, and if so inclined sign up for a how-to-tile-the-bathroom class before you botch the job. Plus there are lumberjack-like customer service reps who have a clue -- they know a star driver is not a guy with a tinted-windows limo in Beverly Hills.

Stunning practicality, shrewd management, and simple investor enthusiasm have hoisted the stock to great gains, particularly over the last three years. It's market cap hovered over $130 billion recently. Home Depot supplanted Sears as a member of the Dow Jones Industrials in the fall of 1999 (and in January it became a member of The Motley Fool's NOW 50 index). By that time, it was already a 26-bagger stock for decade-long holders. Clearly the store and its can-do wares have become an important part of the American landscape.

Home Depot got its start back in 1978, with retailers Bernie Marcus and Arthur Blank. They founded the company and built it, catching onto and fostering a burgeoning do-it-yourself movement in the U.S. There's even a book now: Built from Scratch: How a Couple of Regular Guys Grew The Home Depot from Nothing to $30 Billion.

Home Depot has not only provided the framework for countless houses, decks and fortifications. For some folks who got in on the initial public offering (IPO) back in 1981 it has literally feathered a retirement nest. Consider that a share of Home Depot issued at $12 back at the IPO has grown into 340 shares through splits, worth $20,400 today (at $60 per share).

To reach that cozy point of having a retirement home built by Home Depot, however, investors have had to run a gauntlet of naysayers proclaiming the sky will fall, the house will cave in, and that fat P/E will cause a bad sprain. An enthusiast who retired on his Home Depot easy chair explains:

"If I had listened to the many money managers I contacted when friends insisted I needed help managing my money when my stock became worth a great deal, I would have sold HD starting in 1984. Every one of them said HD could not continue to grow at that rate. The P/E was too high. The competition was on their heels. They couldn't find enough qualified people to staff the stores. The reasons to sell went on and on."

So what happened? One, the do-it-yourself phenomenon was catching on in two car garages everywhere. A construction boom in parts of the nation didn't hurt either. Home Depot's huge but bare-bones stores rely on quantity, variety, and economy. An economy of scale allowed the store to make profits while providing a good bargain to customers.

Those individual investors who hung on despite shrieks of "sell!" probably threw in a toss of common sense. Go there and the lots are packed. Talk about it and everyone knows the name. Drive around and you'll pass one. Home Depot had captured the attention of the home improvement public and the small investor.

In a Rule Maker portfolio column entitled "The Case for Home Depot" from earlier this year, Rob Landley made a case for Home Depot fitting the profile of not only a Rule Maker but also a Merchant King stock -- that is to say it has a great handle on getting repeat-purchase business:

"Being a Merchant King is all about combining low overhead and high inventory turnover, and no matter how the housing market goes, Home Depot is poised to serve both new construction and maintenance/repair/upgrade needs from lumber to carpeting to light bulbs to lawn care. Its strategy is to win customers back again and again by being the cheapest and most convenient place to shop for home improvement products."

It's a great scenario. When people are building new homes, they can find supplies at Home Depot. When money is tight and they can't afford a professional upgrade, they can try it themselves with help from Home Depot. And when a little just-in-case fortification is needed -- Home Depot. Next time your local television station does some advance hurricane or winter storm coverage, just try to watch for a day without seeing a story about how everyone went shopping for basic supplies.

Whether it was the right orange logo, the simple, catchy name, good locations, pure dumb luck, or all these and a combination of other factors, Home Depot rose above the competitors as a favorite of U.S. consumers. It has curb appeal. Meanwhile Hechinger and Builder's Square have become vague memories. And do you shop at Lowe's? Home Depot is the store of choice.

Home Depot has expanded at an impressive pace to around 800 stores, with many more on the ASAP schedule. In its third quarter report for 1999, Home Depot reported sales rising some 27%, net profits up 45% and earnings per share (EPS) rising more than 40%, benefiting from higher margins thanks to lower merchandise costs. Earnings for the last year are estimated at around $2.2 billion. Given it's similarly hearty past, Home Depot is easily a stock to love.

Why does the future look like a dozen long-stemmed roses? Home Depot is not yet a developed international chain, and I have to believe that folks from Amsterdam to Zurich still would like to find a nice, cheap place to buy a faucet. Home Depot does have stores in Canada, with expansion into Puerto Rico and South America. And the chain is keeping its brand current by experimenting with gigantic EXPO Design Centers as well as Villager Hardware. Clearly management is interested in keeping close tabs on the pulse of consumer interests.

The balance sheet looks truly healthy, too. As described in "A Case For Home Depot," even what doesn't look like a good thing at first glance really is -- net margin of only 5.8% reinforces that Home Depot is passing along great deals to its customers like a good Merchant King should. Home Depot's three-year EPS growth has been projected at around 24%. With its next earnings report anticipated on the 22nd of February, Home Depot is a stock worth looking at, and maybe hugging tightly this Valentine's Day.

Next: Tootsie Roll Industries Inc. »

Home Depot Company Information:
Trades on the NYSE under symbol HD
Home Depot is a Motley Fool NOW 50 Index Stock

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