Dividend growth investing is all about buying the best stocks in the world and holding them for the long haul. But how can you tell a great stock apart from a terrible one? Winners tend to have brands that are well-recognized and trusted, which helps sales and profits to grow over time.
Few companies fit these requirements better than the home improvement retailer Home Depot (HD 0.02%). Let's take a look at why the stock is a no-brainer buy for investors building a dividend growth stock portfolio from scratch and those looking to strengthen their existing portfolio.
The undisputed heavyweight champion of its industry
One year after its founding in 1978, Home Depot's vision of a one-stop shop for do-it-yourselfers (DIY) became a reality. Now with more than one million products available for the DIY customer, professional contractors, and the do-it-for-me customer, Home Depot has more products than you could ever imagine.
Due to continued expansion in its product offerings and additional store openings, the company holds approximately 18% of the $900 billion home improvement retail market. This is significantly greater than the 11% market share held by Lowe's, the next closest peer to Home Depot.
In the middle of last month, Home Depot shared its financial results for the third quarter ended Oct. 30. The company's net sales increased 5.6% year over year to $38.9 billion in the period. How did the mega-cap retailer deliver respectable net sales growth with elevated inflation during the quarter?
Home Depot's comparable average ticket grew 8.8% over the year-ago period for the quarter. According to the company's executive vice president of merchandising, Jeff Kinnard, this growth was mostly the result of inflation and the resulting price hikes in build materials, lumber, and copper. These price hikes were reasonably tolerated by customers, which is why comparable transactions fell just 4.3% year over year in the period. Along with the store count reaching beyond 2,300, this explains the 5.6% net sales growth rate during the quarter.
Home Depot's diluted earnings per share (EPS) rose 8.2% over the year-ago period to $4.24 for the third quarter. As a result of a 5.7% growth rate in the company's cost of sales, its net margin fell five basis points year over year to 11.2% in the period. Home Depot's reduced profitability was more than offset by a 2.8% decline in its diluted weighted average share count. This is how diluted EPS growth topped net sales growth during the quarter.
If major North American economies were to experience a recession, Home Depot could be unfavorably impacted to an extent. But with analysts anticipating a blistering 15.7% annual diluted EPS growth rate from Home Depot over the next five years, a temporary slowdown in growth wouldn't be the end of the world.
Image source: Getty Images.
Home Depot could become a Dividend Aristocrat
Stacked against the S&P 500 index's 1.6% dividend yield, Home Depot's 2.4% yield is quite appealing. And the dividend payer becomes even more attractive when considering that its current 12-year dividend growth streak puts it on track to become a Dividend Aristocrat in 2035.
Home Depot's dividend payout ratio is poised to come in at 45.6% for this fiscal year. This gives the company the flexibility to open more stores, strengthen its balance sheet, and further reduce its share count. Therefore, I believe that the dividend growth rate will marginally exceed earnings growth over the next few years. This should mean that Home Depot has quite a few years of double-digit dividend growth in its future.
It's a winning stock at a fair valuation
Turning a $10,000 investment in 1981 into nearly $70 million today, Home Depot is one of the winningest stocks of all time. And investors looking to buy and hold the stock for the long run are in luck.
This is because Home Depot's forward price-to-earnings (P/E) ratio of 19 is barely above the home improvement retailer industry average forward P/E ratio of 17.6. That's hardly an unjustified premium for an unbelievable wealth compounder.
