Your house is often the largest purchase you'll make in your lifetime. Unfortunately, housing is getting increasingly costly, thanks to rapid home appreciation over the past few years and a spike in mortgage rates. High housing costs will impact the economy and consumers in various ways, but it could be a big boost for Home Depot (HD 0.22%).
Stock for the home improvement retailer is trading down 31% from its high, making the housing situation a potential buying opportunity for those interested in holding shares for the foreseeable future. Here is why the housing market is setting up to create substantial growth for this retail success story.
Will people stop moving?
Interest rates rose at the fastest pace in decades in 2022, and the economy is starting to feel the impact. Mortgage rates surged, more than doubling since the start of 2022. That surge impacts a buyer's monthly payment more than you might realize.
For example, the median price of a U.S. home is roughly $430,000. Assume you bought the average home with a 20% downpayment and financed the remaining $344,000 at a 3% rate on a 30-year mortgage. That would give you a monthly payment of $1,450.
Now, assume you bought the same house but did so recently, financing at a 6.4% mortgage rate (the current going rate). Your mortgage payment would rise to $2,152, a 48% higher payment for the same loan.
30 Year Mortgage Rate data by YCharts
That's a tough pill to swallow for people who bought or refinanced during low rates, who may choose to stay put instead. According to mortgage banking software company Blend Labs, mortgage volumes declined 68% year over year in the fourth quarter.
How does a home sales drop benefit Home Depot?
What will people staying put do with their money if they are not saving for a downpayment? They could instead put it toward improving the home they are already in, investing in building value in a house that might otherwise decline in value as the market cools off. Home Depot is the country's largest home improvement retailer, dominating the market with its chief competitor Lowe's.
Home improvement spending was up an estimated 14.5% in 2022, and following that up will be tough after a year of rampant inflation. Predicted spending growth for 2023 will slow sharply to 2.3%, but that's still an increase despite a potential recession hitting the country this year. A report by Harvard highlights roofing, HVAC, and general maintenance as key spending areas that could drive growth in the coming years.
Additionally, millennials between roughly 27 and 40 years old are coming of age as the primary consumer in the economy. Their tastes and higher income could support remodeling demand as they update older homes to their liking.
The stock's fall creates an opportunity
Home Depot's stock now trades at a price-to-earnings ratio of 17, near its lowest valuation over the past decade. Given such a sharp decline, you would think Home Depot's growth days are over. Admittedly, analysts' estimates for this year's earnings per share (EPS) are calling for a decline in profits.
But that could be what happens when you follow strong sales years like 2020 through 2022, not to mention when a cooling economy impacts business. Things look much better further out -- analysts expect 11% annual EPS growth over the next three to five years. In other words, Home Depot's growth should return after a down year.
HD PE Ratio data by YCharts
Given the transition to millennial homeownership and the stock's cheap valuation, investors could make out well if they're willing to hold the stock for at least a few years. Home Depot's compelling story as a long-term investment doesn't look like it's ending anytime soon.
