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Why Home Depot Deserves a Place in Your Portfolio

By Saket Jhajharia – Updated Aug 14, 2020 at 1:19PM

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This home improvement retailer has a long history of strong earnings and dividend growth.

The Home Depot (HD 0.06%) has rewarded patient long-term investors with a total return of over 1,000% in the last ten years, cementing its status as a best-in-class retailer.

With an existing network of 2,300 stores already open all over North America, let's see if Home Depot's massive returns can continue into the future.

The track record

Fueling Home Depot stock's rally over the past decade was steady top- and bottom-line growth. Over that period, the company's revenue and earnings per share (EPS) enjoyed compound annual growth of 5.3% and 20.0%, respectively.

That strength continued in the first quarter of 2020 despite the pandemic. Home Depot reported net sales growth of 7.1% year over year on the back of an 11.0% increase in average ticket size, which mitigated the 3.9% decline in customer transactions.

Even amid the crisis, the company leaned into its "One Home Depot" strategy. The initiative began with the aim of creating an interconnected shopping experience between the digital and physical channels for customers. To achieve this, Home Depot invested heavily to build an e-commerce solution, develop supply chain expertise, and implement in-store enhancements. 

In the shadow of COVID-19, the One Home Depot strategy clearly paid off, with digital sales coming to the rescue as the company was able to quickly offer its curbside pickup option for customers. Management commented in the most recent earnings call:

Investments we have made over the years in our stores, market-leading digital assets, flexible supply chain, and a world-class merchandising organization have allowed us to quickly adapt to shifts in customer needs, preferences, and behaviors. Our interconnected retail strategy and underlying technology infrastructure have supported record level web traffic for several weeks without disruption.

Sales leveraging our digital platforms increased by approximately 80% in the quarter. And more than 60% of the time, our customers opted to pick up their orders at a store. We were able to extend our in-store focus capabilities to curbside pickup in the US in a matter of days, offering customers an additional choice with respect to fulfillment.

Despite the increase in sales, net earnings came in 10.7% lower. This shortfall was largely due to the $850 million of pre-tax expenses behind various initiatives to support employees, such as expanding paid time off for hourly associates.

Can growth continue?

Home Depot has taken advantage of its status as an "essential retailer" by providing customers with the necessary supplies for home improvement and repairs. A quick look at new residential sales from a report published on July 24 by the U.S. Census Bureau shows that the number of homes sold has been on an uptrend since 2015 with occasional dips. More specifically, new home sales rose by 13.8% month to month and 6.9% year over year in June.

Similarly, MarketWatch reported that existing home sales are also seeing an uptick. The increase in home sales -- both new and existing -- is a good sign that demand will remain strong long-term for Home Depot.

Management noted during the earnings call: "But for the most part, those dynamics in the housing economy that most influence home improvement demand have remained relatively stable. And so we haven't seen anything that really changes our view of how the housing economy will impact home improvement."

Dividend payout and potential

The home improvement giant announced a 10% payout increase in February, bringing the quarterly dividend to $1.50 per share, or $6.00 annually. Since 2015, Home Depot's quarterly payout has nearly tripled, and the stock yields 2.3% as of this writing.

The stability of Home Depot's dividend is supported by strong free cash flow. The company generated $12.2 billion of free cash flows over the past four quarters and distributed approximately half to shareholders, putting its free cash flow payout ratio in a healthy range.

Home Depot's consistent execution and strong financial position should lead to consistent dividend increases in the years ahead for patient investors.

Reaffirming its position as a source of stability for investors to ride out the current uncertainty, management said during the earnings call:

As we look ahead, we are focused on continuing to provide essential products and services to our customers and communities in a safe and responsible way. The investments we have made across our business has helped us to be flexible and agile in this fluid and dynamic situation. We will continue to adapt and improve the ways in which we serve customers in this new environment.

Home Depot can continue to outperform the retail sector overall, and investors would be wise to pick up shares before the stock builds on its 20% year-to-date gains.

Saket Jhajharia has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Home Depot and recommends the following options: long January 2021 $120 calls on Home Depot and short January 2021 $210 calls on Home Depot. The Motley Fool has a disclosure policy.

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