After years of incredible results, the home-improvement retail industry has lost momentum in recent months. And it's not hard to figure out why: Surging interest rates, high inflation, and a cooling economy all played a role.

Boasting a market share of over 15% in a $900 billion market, Home Depot (HD -0.03%) is the most dominant retailer in the home-improvement space. Taking recent economic events into account, one might ask: Should investors seeking dividend growth consider building their portfolio around Home Depot stock? Let's look at the company's fundamentals and valuation to decide.

This too shall pass

Bernie Marcus and Arthur Blank deserve credit for the transformation of the home-improvement retail landscape. When the two industry pioneers opened their first store in 1979 in Atlanta, they had a bold goal in mind: Offer a one-stop shop for the do-it-yourself (DIY) customer with a massive, warehouse-size store. Home Depot grew to more than 2,300 stores in the U.S., Mexico, and Canada, so it's safe to say that the duo accomplished that vision.

In recent years, the company has led the way in the latest evolution of the industry: the rise of the professional contractor as a customer. This gives the company the leg up on profitability over Lowe's, because pros spend both more per transaction and more frequently than DIY customers.

Metric Q1 2022 Q1 2023
Comparable-sales growth rate 2.2% (4.5%)
Total store count 2,316 2,324
Net margin 10.9% 10.4%

Data source: Home Depot. 

Home Depot's net sales dipped 4.2% year over year to $37.3 billion in the first quarter, which ended April 30. Price increases during the quarter passed onto customers helped improve the company's comparable average ticket (average transaction amount) by 0.2%.

But elevated interest rates and less disposable income prompted fewer consumers to visit Home Depot's stores. This explains how comparable transactions (such as total transactions at existing stores) fell by 5% for the quarter. The company's decline in foot traffic within its stores was only partially offset by select store openings in the past 12 months.

Home Depot's diluted earnings per share (EPS) decreased by 6.6% over the year-ago period to $3.82 in the first quarter. Because the company's operating expenses contracted at a lesser rate than net sales during the quarter, its profitability was slightly reduced. This was only somewhat counteracted by a lower diluted share count for the quarter, which is why diluted EPS growth dropped by more than net sales.

The near future doesn't look promising for Home Depot. But if the company has proven anything over the course of its decades-long corporate history, it's that it always bounces back. That's why analysts expect Home Depot to return to earnings growth beginning in its fiscal year 2024.

A customer shops at a home improvement store.

Image source: Getty Images.

The market-beating dividend is safe

Home Depot's current 2.8% dividend yield is markedly higher than the S&P 500 index's 1.7% yield. On top of the high starting income that the company provides, it has also delivered remarkable dividend growth to shareholders: The quarterly dividend per share has doubled in just the last five years.

HD Dividend Chart

HD Dividend data by YCharts.

The dividend payout ratio is poised to come in at around 60% for the current fiscal year (ending in January 2024). Since this is more toward the high end for Home Depot, I anticipate that the next payout increase will be modest. But as the company rebounds from the currently unfavorable business environment, dividend growth should pick back up shortly thereafter.

A well-earned valuation premium

Shares of Home Depot have shed 8% of their value to start 2023. At the current $290 share price, this has arguably put the stock into buyable valuation territory. Home Depot's forward price-to-earnings (P/E) ratio of 18.4 is moderately above the average forward P/E of 16.7 for the home-improvement retail industry. But its industry leadership makes it worthy of the premium that it currently enjoys over its peers, so I believe the stock is a long-term buy for dividend growth investors.