Investing in dominant businesses in huge industries often works out for investors. That is because such companies have an easier time generating revenue and earnings growth for shareholders.
Home Depot (HD 0.94%) arguably matches the above description. Thus it shouldn't come as a surprise that after freezing its dividend in 2008 and 2009, the company has hiked its payout for 14 consecutive years. Even after this impressive growth streak, Home Depot stock looks like a buy. Let's investigate Home Depot's fundamentals and valuation to see why.
It's always darkest before dawn
Operating more than 2,300 stores in all 50 U.S. states, four U.S. territories, 10 Canadian provinces, and Mexico, Home Depot is a true industry titan. Thanks to its wide product selection and nearly 500,000 associates, the company commands over 15% of the approximately $900 billion North American home improvement market.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Comparable store sales growth rate (YOY) | 5.8% | (2%) |
| Total store count | 2,316 | 2,326 |
| Net margin | 11.8% | 10.9% |
Data source: Home Depot. YOY = year over year.
The recent period has been a challenging one for Home Depot. Net sales fell 2% year over year to $42.9 billion during its fiscal second quarter, which concluded July 30. With mortgage rates at around the highest levels in years and inflation eating into disposable income, traffic was down at the company's stores over the year-ago period. This is what led to a 1.8% year-over-year decline in customer transactions for the quarter. Neither the 0.1% increase in the average purchase nor the company's additional store openings were able to offset these headwinds.
At the bottom line, diluted earnings per share (EPS) decreased by 7.9% over the year-ago quarter to $4.65. Thanks to the inflationary environment, the company's total operating expenses rose even as net sales shrank. This is what led Home Depot's net margin to contract by just shy of 100 basis points from a year ago. The retailer's share buyback program and resulting drop in its diluted share count only partially countered reduced profitability. That is why diluted EPS slumped more than net sales during the quarter.
Home Depot has endured numerous challenging economic environments throughout its corporate history and emerged stronger every time. And the good news is that this time looks to be no different; as the economic cycle plays out, mortgage rates and inflation will both eventually return to levels that foster net sales and profit growth for Home Depot. This explains why after a decline in diluted EPS this fiscal year, the analyst consensus is that the company will return to growth for next fiscal year and beyond.
Image source: Getty Images.
No end in sight for payout growth
Right now, Home Depot's 2.5% dividend yield is probably enough relative to the S&P 500 index's 1.6% yield to garner the attention of income investors. And having upped its quarterly dividend per share by a whopping 800%-plus since 2009, the company hasn't been a slouch on dividend growth, either.
Home Depot's dividend payout ratio is positioned to register at roughly 55% in the current fiscal year ending in January. This payout ratio should allow the company to balance the capital it allocates to further store openings and debt repayment with generous payout increases.
HD Dividend data by YCharts
A first-class stock at a sensible valuation
Despite difficulties seen in the home improvement retail industry lately, Home Depot shares have partly participated in the 2023 market rally, gaining 5% so far this year. Home Depot's forward price-to-earnings (P/E) ratio of 20.9 is above the industry peer average of 19.1. But for its industry-leading status, that is hardly an excessive valuation. Together with the prospect of brighter days ahead for the business, this bolsters my view that shares of Home Depot remain a buy for dividend growth investors.
