Sales are surging at Home Depot (HD -0.31%), but that does not automatically make its stock a buy. The home improvement retailer is benefiting substantially as consumers have fewer options to spend their income. The stock is already up 26% year to date, so it could be that the recent surge is baked into its current price.
And there is a risk that with all that home-improvement spending done by consumers during the pandemic, there will be home-improvement fatigue, or a limited amount of projects left to be done around the home. That could potentially depress sales in the near term when the pandemic fades away, and consumers start having more options for their disposable income.
To determine whether or not the stock is a buy, let's look at the company's long-term prospects and then compare it with some valuation metrics.
Image source: Home Depot.
Home Depot is ready to serve homeowners
Home Depot is a rare brick-and-mortar retailer with an advantage over Amazon. The types of products it sells make it more likely that a customer will want to visit one of its 2,293 locations to touch, feel, or measure before making a purchase.
And the company is making significant investments in its digital capabilities through its $11 billion One Home Depot program. It recently added the option in select stores to order online and pick up curbside, with an associate bringing the item to your car in a Home Depot parking lot. Anyone who has been to one of its stores knows that many of the items sold can be quite heavy and bulky. Being able to buy online and have Home Depot deliver the item to your home or to your car at curbside could add incremental sales in the long run thanks to the convenience.
Lastly, after declining for over a decade, the homeownership rate in the U.S. has been trending upward since 2016 and surged during the second quarter of 2020 during the peak of the pandemic. Record-low mortgage rates and the likelihood that a larger percentage of the population will work from home even after the pandemic might keep the homeownership rate elevated for at least a few more years. And owners tend to spend more money on their property than renters do, and some portion of that spending will go to Home Depot.
Data source: Ycharts.
Valuation and performance
Home Depot currently sells at a price-to-earnings ratio of 22.8 and a price-to-sales ratio of 2.349. That's at a premium compared to its rival Lowe's (LOW -0.14%). But that can be justified considering that Home Depot outperforms Lowe's in at least a few important metrics. And over the last 10 years, the gap is widening in favor of Home Depot in terms of net profit margin and return on invested capital (ROIC).
Home Depot is selling near its peak P/E and P/S levels compared to its own historical ranges. But it's also achieving peak performance as evidenced by its increasing ROIC and profit margin. You're buying a better company today than you were a few years ago. Moreover, when interest rates are lower, you should be willing to pay higher multiples because future cash flows are discounted at a lower rate, increasing their present values. And interest rates today are near record lows.
The verdict
Overall, record-low interest rates might spur increases in already high homeownership rates for several years. That, along with higher levels of remote working than before the pandemic, will help drive sales for Home Depot. Moreover, projects that required professionals to come to a person's home that were put off during the pandemic might start back up afterward.
Those excellent long-term prospects and a relatively fair valuation make this consumer discretionary stock one that investors can feel good about adding to their portfolio.
