The investment climate has been rough this year with the S&P 500 dropping by about 24% since the start of 2022. That's due in large part to the Federal Reserve combating elevated inflation by aggressively raising interest rates. This environment has led economists to increasingly believe a recession is on the horizon.
This would likely hurt Home Depot's (HD -1.77%) results since they are sensitive to the economic cycle. Indeed, the stock price has fallen 31% this year. However, the climate makes it a good time for long-term investors to investigate the company's prospects to see if it's a good time to purchase shares.
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Near-term challenges
Higher mortgage rates have already begun to cool the formerly red-hot housing market. Since the start of the year, the 30-year fixed mortgage rate has increased from 3.2% to 6.7%. And existing home sales have fallen for seven straight months through August.
Since many buyers look to fix up their homes when they move in, this presents a challenging short-term picture for the company. Higher interest rates also make it more expensive for existing homeowners to finance large projects, which will also likely hurt Home Depot's results.
These macroeconomic factors have yet to impact the top line, however. In the second fiscal quarter (ended July 31), Home Depot's same-store sales (comps) increased by 5.8%.
It's instructive to look at the company's results during the housing meltdown from 2007 to 2009. In fiscal 2008 (ended Feb. 1, 2009) and fiscal 2009 (ended. Jan. 31, 2010), comps fell by 8.7% and 6.6%, respectively. But they rebounded the following year, increasing by 2.9%, and the company's sales were back on track.
Hence, while Home Depot's sales may feel the effects from a slower housing market, this will likely prove temporary. That's because the company remains in a strong competitive position as the world's largest home improvement retailer by sales.
Valuation and dividends
The price drop has made Home Depot's valuation more attractive. Based on the price-to-earnings (P/E) ratio, the stock trades at a 17 multiple. That's down considerably from the P/E ratio of 28 at the start of 2022. The current valuation is also below the stock's 10-year average of 23. For patient investors not looking to time the bottom of the market, this could very well prove an attractive entry point given the company's long-term prospects.
In the meantime, you can patiently collect your dividends. Earlier this year, the board of directors increased the quarterly payment by more than 15% to $1.90. Home Depot has raised the payout annually since 2010.
And it generates plenty of free cash flow to support dividends. For the first half of this year, free cash flow was $5.7 billion while dividends were $3.9 billion.
While the Federal Reserve's actions may make a recession a greater possibility, which would hurt Home Depot's short-term results, people will flock to the stores once the economic environment improves. Should this happen, you can collect dividends while waiting for sales to grow again and the stock price to follow. Your patience will undoubtedly get rewarded through income and capital appreciation.
