When applied to growing businesses, the law of large numbers states that any company growing too fast in comparison with its peers will eventually begin to revert to the industry average. This is not only due to competitive reasons, but also the fact that the larger a company becomes, the harder it is for that company to maintain the torrid growth rate it experienced when it was smaller. After all, even the best-run chains eventually run out of places to open new locations, and world-class platforms run out of potential new users.
One company that seems to be defying this rule is Home Depot Inc (NYSE:HD). In April 2014, Home Depot turned its attention away from opening new locations to focus on e-commerce and to run a more efficient business model, and thus far, the strategy seems to be working brilliantly. Since then, Home Depot shares have appreciated about three times that of the S&P 500. With such a strong recent history of stock gains, though, some might wonder if Home Depot's run is nearing its end. I don't believe it is. In fact, given the store's strength in e-commerce, strong product pipeline, and ability to make smart, bolt-on acquisitions, I believe investors who continue to hold shares might see even greater market-beating returns over the next four years.
One Home Depot
While Home Depot is given plenty of credit for its online operations, I wonder if most investors understand how well the company has integrated its digital and brick-and-mortar properties. Home Depot refers to its integration efforts as "One Home Depot" -- as in, there is only one shopping experience for the Home Depot customer, and it often involves both a digital and in-store visit. At last year's Shareholder and Analyst Day, Chief Marketing Officer Kevin Hoffman stated:
[W]e know that 60% of all of our sales in store or online are influenced by a digital visit, and we've continued to maintain our traffic advantage. We will surpass 1.8 billion visits this year, and our digital visits now rival our physical store transactions ... our online sales penetration is about 6.4%, approximately double our nearest traditional competitor. Home Depot now has one of the largest e-commerce operations in the country ... we continue to take share in key categories. So these interconnected retail efforts continue to be a key growth engine for our overall business. And over the last few years, they've contributed approximately 20% of the company's total growth.
The company has grown its online business by more than $1 billion per year over the past four years and is now the seventh-largest e-commerce retailer in the country, according to Internet Retailer. In its latest quarter, online sales increased 21% year over year and now make up 6.7% of all the store's sales. As far as integration efforts go, CEO Craig Menear pointed out in the company's fourth-quarter conference call that 46% of online orders are now picked up in the store. The company is also using the data it collects on its customers to tailor personal marketing messages to individual customers.
Where product is king
In the company's fourth-quarter conference call, Vice President Edward Decker said, "Product innovation and speed to market allow The Home Depot to maintain its position as the #1 retailer in product authority and home improvement." Decker also said the company was "constantly collaborating with our suppliers to deliver new products exclusively to The Home Depot." The ability to offer exclusive and innovative products is a key strategy for the company in getting customers to keep returning to stores.
At a previous investor conference, Decker said Home Depot knows its customers are finding value in the products it offers because of the company's experimentation, not only with premium pricing, but super-premium pricing as well. Decker concluded that the customer always pays up for innovation. This seems to be backed up by the results. In its latest quarter, Home Depot saw comparable-store sales increase by 7.5%, the majority of which gains came from an increase in the size of the average customer's ticket (up 5.5%), not from an increase in foot traffic (up 2%).
In recent years, Home Depot has made two major acquisitions. The first is already beginning to pay off, and the second shows a lot of foresight and holds lots of potential, though it is still too early to make a definitive call.
In 2015, Home Depot acquired Interline Brands, a leading wholesale distributor for maintenance, repair, and operations (MRO) for $1.6 billion. The integration of Interline with Home Depot is being implemented in phases. The first phase, long since completed, consisted of carrying Interline products in-store with delivery capabilities. The second phase, nearing completion, allows Interline account holders to make purchases at Home Depot locations using their account numbers. While Menear did not give a detailed update in the company's fourth-quarter conference call, he did say, "we're pleased with the progress, pleased with the results." He also said each of the three end-markets for Interline -- institutional, multifamily and trades -- all saw strong sales growth.
Just before Christmas, Home Depot showed its softer side when it acquired the online properties of The Company Store, a company more focused on home goods like bedding, pillows and rugs than lumber and power tools. Management said this acquisition was about keeping the customer at Home Depot through to a project's completion. After all, if a couple is redoing a room and comes to Home Depot for building materials, paint, and flooring, there is no reason that same couple can't stay at Home Depot for the final touches such as drapes and throw rugs if the company can provide a selection of these items.
A home run
Far from showing signs of giving way to the law of large numbers, Home Depot is carrying on as if it plans to dominate the home improvement industry for a long time to come. In its fourth quarter, net sales increased 7.5% year over year, and earnings per share, once adjusted for the new tax legislation, increased 17.4% year over year. It also announced another healthy dividend increase and more share buybacks. This is a company on top of its game, and rather than worrying about whether the stock price has gone up too far and too fast, investors might want to start thinking about whether now is a good opportunity to add more shares to their portfolio.