Building a diversified portfolio of stocks that pay ever-higher dividends to their shareholders is the dream of every dividend growth investor. So, the best question to ask is as follows: How can investors make that dream a reality?
This can be accomplished by buying quality businesses for the long haul and simply holding them as long as the investment thesis is intact. Quality can mean many things, but one of the most obvious indications of quality, in my opinion, is leadership within a company's industry.
With a $315 billion market capitalization, Home Depot (HD 0.94%) is more than double the size of Lowe's (LOW -0.04%), its next-closest competitor in the home improvement retail industry. Let's dig into what makes Home Depot a passive-income machine that income investors can't afford to ignore.
The company continues to outperform
On Aug. 16, Home Depot released its financial results for the second quarter, which ended July 31. Unsurprisingly, the home improvement retailer nailed down another quarter of exceeding the analyst consensus for both net sales and diluted earnings per share (EPS).
| Year-ago quarter net sales | Second quarter net sales | Growth rate |
|---|---|---|
| $41.1 billion | $43.8 billion | 6.5% |
The company recorded $43.8 billion in net sales in the second quarter, which was just ahead of the average analyst estimate of $43.3 billion for the quarter. What led to Home Depot's 10th net sales beat in as many quarters? The company's comparable sales increased 5.8% year over year, which is especially remarkable considering that it faced an otherwise difficult comparison period with high inflation.
According to Chief Financial Officer Richard McPhail, Home Depot's favorable customer demographics were largely responsible for this impressive performance. Importantly, that includes professional contractors, who spend on behalf of homeowners. Couple this with the fact that over 90% of its do-it-yourself customers are homeowners, and it becomes clear that Home Depot appeals to a more financially stable customer group.
Along with a 0.8% increase in the company's store count to 2,316 stores, this explains its healthy net sales growth in the second quarter.
Image source: Getty Images.
Home Depot is growing more profitable
| Year-ago quarter diluted EPS | Second quarter diluted EPS | Growth rate |
|---|---|---|
| $4.53 | $5.05 | 11.5% |
Home Depot generated $5.05 in diluted EPS during the quarter, which was a bit more than the $4.95 that analysts were expecting -- and it was the ninth straight quarter that the company surpassed the average analyst prediction.
Disciplined cost management led to just a 3.5% growth rate in selling, general, and administrative expenses in the second quarter. This is how Home Depot's net margin edged 12 basis points higher to 11.8% for the quarter.
Add in a 3.5% reduction in the company's outstanding share count to 1 billion, and this is what allowed Home Depot's diluted EPS growth to outpace net sales growth during the quarter. Continued share repurchases, margin expansion, and steady demand for home improvement goods and services are why analysts are anticipating 15.7% annual diluted EPS growth through the next five years.
The dividend could double in five years
Home Depot's 2.6% dividend yield is significantly above the S&P 500 index's 1.6% yield. And above-average income prospects aren't the only thing that Home Depot has going for it.
It's projected that the company's dividend payout ratio will be a manageable 46% for the current fiscal year. Since this payout ratio enables Home Depot to retain the capital necessary to grow its business, this should translate into dividend growth as fast as earnings growth for the medium term. That's why I believe that the dividend will roughly double over the next five years.
A business worthy of its premium valuation
Home Depot's fundamentals are robust, which is why it is trading at a slightly higher valuation than its industry peers.
The stock's forward price-to-earnings (P/E) ratio of 17.1 is a tad above the home improvement retail industry average forward P/E ratio of 15.8. But this is justified by Home Depot's 15.7% annual earnings growth forecast, which is also higher than the industry average of 14.2%. This makes the stock a compelling buy for investors seeking to compound their dividend income and wealth.
