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3 Terrible Reasons to Sell Home Depot Inc. Stock

By Demitri Kalogeropoulos - Oct 7, 2017 at 11:00AM

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Why you might look back in a few years and regret selling this stock.

Home Depot (HD 0.17%) has trounced the market so far this year even while many national retailers are setting new five-year lows. The rally might provide a good opportunity to sell the stock if you've found a more promising use for the funds or have decided that your investing thesis is broken.

You don't want to part with such a high-performing business for the wrong reasons and then regret it later, though. Below, we'll highlight three of the worst justifications for selling Home Depot stock today.

Timing the next downturn

The home improvement market has been on a cyclical upswing for years, with home prices surging and spending on capital improvements doubling to an over $700 billion pace from a low of about $350 million in 2010.

Chart showing a rebound in home improvement spending.

Spending on fixed residential investments. Data source: Federal Reserve Economic Data.

That spike has been the main engine behind Home Depot's -- and rival Lowe's (LOW -1.22%) -- steadily rising customer traffic, higher average spending, and soaring profits. It's natural, then, to worry about the time when (not if) industry trends turn back in the other direction. As a Wall Street analyst put it in a recent quarterly conference call while asking about potential yellow flags, "the market is getting some angst that there's eventually going to be a [shoe to] drop."

There's no telling when the industry might start contracting again. However, a few metrics suggest that there's plenty more room for growth. Housing affordability remains high, the stock of existing housing is aging, and spending in the industry is still about 30% below the peak it set in 2006.

In any case, the last industry pullback, despite its severity, didn't sink returns for long-term investors. In fact, if you bought Home Depot's stock in late 2007 you'd be up over 400%, compared to a 66% gain for the broader market.

Worries over competition

Home Depot has outpaced Lowe's by nearly every key operating and financial metric, including sales growth, profitability, and return on invested capital. Unusually strong comparable store sales gains are really the foundation for the performance gap, since they reflect market share gains by the industry leader. And Home Depot is widening its lead here. Its comps rose 6% last quarter, compared to a 4.5% uptick for Lowe's.

A customer picks out a piece of lumber.

Image source: Getty Images.

Lowe's has decided to get more aggressive at defending its position. Following a surprisingly weak start to the year, management in late August announced a new initiative that, at the expense of profitability, will keep stores open longer in a bid to boost customer traffic.

Yet Home Depot is already succeeding in this arena. Shopper traffic gains sped up to a 2.8% pace last quarter from 1.6% in the prior quarter thanks to strength across its sales categories, especially in the pro customer segment. The company raised its growth outlook to a 5.5% pace while Lowe's kept its more modest 4% target unchanged. Unless Lowe's can engineer a big rebound over the next few months, 2017 is likely to be another year of significant market share gains for Home Depot.

Boring returns ahead

It would also be a mistake to sell Home Depot stock because you're convinced it's destined for weak long-term sales gains. Sure, its store base has held steady for years, and the company has no aggressive plans to expand into new international markets.

However, the company is adding to its sales potential through moves like attacking the pro customer segment and acquiring its way into the maintenance, repair, and operations segment. These shifts give it a total addressable market of well over $500 billion, compared to the core product retailing segment it currently dominates of about $300 billion.

That growth runway has given management the confidence to predict passing $100 billion of annual sales sometime next year, even as profitability hits a new record. At the same time, shareholders can count on major direct cash returns in the form of dividends and share repurchases. Healthy results like those aren't easy for investors to find, which is why they suggest being cautious as you consider selling Home Depot stock.

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Stocks Mentioned

The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
$274.35 (0.17%) $0.48
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
$173.95 (-1.22%) $-2.15

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