Home Depot (HD 0.35%) was posting strong gains throughout the worst days of the pandemic. Revenue jumped 19.9% in fiscal 2020 and 14.4% in 2021, thanks to consumers shifting their spending to home renovation projects. This impressive fundamental performance helped drive the stock up 90% from the start of 2020 to the end of 2021. 

But this massive retailer has seen its business slow down dramatically in recent quarters. And the stock, now off 27% from its peak price, is trading at a price-to-earnings ratio of 18.9, which is below its trailing-five-year average. 

Investors might want to take a closer look at adding this business to their portfolios. That's because there's one major green flag for Home Depot that will get anyone excited about the company's prospects. 

Favorable industry backdrop 

With trailing-12-month revenue of $155 billion, Home Depot is the leader in the home improvement industry, selling merchandise to both DIY and professional customers. The business has proven to be consistently profitable thanks to this scale, and its return on invested capital of over 40% is superb. 

That's certainly an encouraging sign, but what investors should really be focused on is the favorable industry backdrop. According to the National Association of Home Builders, the median age of a house in the U.S. is about 40 years old. Compared to newer houses, an older home requires much more attention when it comes to maintenance and upgrades. And who benefits the most from this? That's right, a company like Home Depot. 

Besides the age of homes, there is a significant shortage of housing supply in this country. It is estimated that the U.S. needs to build 3.8 million new homes to get the suppressed supply to match demand, according to Freddie Mac.  

In this scenario, the lack of supply translates to houses being less affordable for consumers. So, they'll naturally lean toward staying in their existing dwelling while holding off a new purchase. And this will encourage consumers to focus on existing home renovations. 

Borrowing costs also play a factor. Homeowners who were able to secure lower mortgage rates for a couple of years probably don't want to sell. And prospective buyers are most likely hesitating to take on a mortgage at rates not seen in about two decades. Here again, Home Depot can benefit as these consumers decide to spend on upgrades and renovations. 

"We remain very positive on the medium-to-long term outlook for home improvement and our ability to grow share in a large and fragmented market," CEO Ted Decker mentioned in the second-quarter 2023 earnings press release. It's easy to see why. 

Near-term challenges 

The takeaway is that investors who have a long-term mindset, with the intention to hold stocks for five years or more, might view Home Depot's attractive long-term prospects and industry environment as a reason to take advantage of the cheap valuation.

But it's important to understand that the business will face some struggles in the near term. Knowing this reality will ensure investors take the right mental approach before buying shares and have the patience to wait for things to turn positive. 

The management team believes that revenue will drop between 2% and 5% this fiscal year, so there is definitely a reason to temper growth expectations. Difficult comparisons from prior years, consumers who are now spending less on goods and more on services, and just general macro uncertainty are key reasons for the pessimistic near-term outlook. Weaker demand for big-ticket items was also noted. 

But that doesn't take away from the fact that Home Depot, which operates in a $950 billion industry, still has a sizable expansionary runway ahead. That might be enough to entice investors to take a chance on the stock.