A key advantage of a Roth IRA is that it allows you to rack up investment returns without worrying about the tax hit that comes when you withdraw from a traditional IRA. That advantage becomes more powerful over time as the stocks that populate your portfolio accumulate gains that (hopefully) grow to many multiples of your original investment.
Ideally, then, your Roth IRA will be tilted toward healthy businesses that enjoy large long-run growth opportunities. The returns these stocks generate might be accelerated by a management team that prioritizes direct cash returns in the form of stock repurchases and a rising dividend payment.
Home Depot (NYSE:HD) delivers all of that, and more, to investors, which is why I believe it would make a great candidate for your Roth IRA.
The orange elephant in the room
Let's address the biggest concern with this stock right up front. The housing market is a cyclical industry that experiences booms and busts. We're many years into a recovery right now, and home prices have rebounded sharply. Naturally, investors are concerned that Home Depot's market-thumping sales and profit gains are destined to come to an end as the market turns.
No one knows when the next industry slump will come. But the fundamentals, including housing formation rates, the age of housing stock, and overall home spending, suggest there's plenty of room for more growth in the current expansion. Putting it in baseball terms in a recent conference call with analysts, Home Depot executives estimated that the market recovery is "about in the sixth inning."
Even if it's closer to the end than that, though, retirement accounts like Roth IRAs are perfect for riding through the type of volatility that would be sparked by a surprise housing market decline.
A powerhouse of a business
In the meantime, Home Depot's operating results are the stuff of investors' dreams. Sales growth topped 6% last quarter as customer traffic gains sped up to a 2.8% pace from 1.6% in the prior quarter. The retailer continued to put more distance between itself and peer Lowe's (NYSE:LOW) in important metrics including comparable-store sales, operating margin, and return on invested capital.
Home Depot should pass $100 billion of annual sales in fiscal 2018, while at the same time hitting management's 15% operating margin goal -- ahead of schedule. While they started out the year with conservative expectations, CEO Craig Menear and his team now project maintaining roughly the same impressive 5% comps pace they managed in 2016.
Those growth figures translate into much stronger gains for investors thanks to Home Depot's smart, and shareholder friendly, allocation of capital. The company averages $7 billion each year on stock repurchase spending, and the resulting decrease in the share count has allowed per-share earnings to rise by 15% so far this year, compared to a 10% gain in net profit.
Home Depot's dividend policy make it an attractive Roth IRA candidate, too. Yes, the company was forced to hold its payout steady for almost three years during the worst of the housing market crisis. But since then, management has demonstrated a strong preference for substantially hiking that payout. The dividend rose by 29% this year, following 17%, 26%, and 21% gains in the prior three years, respectively. Home Depot targets returning a generous 55% of earnings to investors through dividends, compared to Lowe's 35% target.
The stock price may look expensive, given that it's close to a record high and up by double-digits so far in 2017, while Lowe's has lost ground. But that's where the long-term focus of a Roth IRA can be your best friend. A few percentage points of extra costs today likely won't make much difference to your overall returns years -- or decades -- from now.