The market is up this year, but Home Depot (HD 0.94%) investors aren't participating in the rally. Its shares are in negative territory on fears that high interest rates will crimp the retailer's sales into 2024. Customer traffic is declining already, in fact, and earnings have fallen compared to last year's stellar results.
Yet cyclical downturns are nothing new in the home improvement industry, and they are always followed by the inevitable rebound. While there's no way to know when that upturn will start, it's even possible the market is on the cusp of another bull market today.
But in any case, Home Depot is a great stock to consider having in your portfolio for the rebound, whenever it does arrive. Here are three reasons why.
1. Market leadership
Home Depot is a leader in the home improvement industry, and that position confers several valuable financial benefits to the business. The chain enjoys excellent market share in both the do-it-yourself crowd and professional contractors. This factor helps sales hold up relatively well compared to peer Lowe's (LOW -0.04%), whose business is more focused on DIY projects.
You can see evidence of that performance gap in Home Depot's profit margin, which routinely clocks in well above Lowe's. The company is targeting margins of near 15% of sales again this year despite slowing sales trends. Lowe's comparable metric sits at closer to 12% of sales.
2. Cash returns
Owning Home Depot means you are likely to enjoy solid cash returns. Sure, the company lacks the multi-decade track record of raising its dividend that Lowe's maintains. But Home Depot routinely sends more than 50% of annual earnings to shareholders in the form of dividend payments while Lowe's targets a more conservative 35%.
That practice helps explain why you'll get a slightly higher yield (2.9%) with Home Depot's stock over Lowe's (2.3%) today.
Cash flow rates are similarly impressive. Home Depot generated more than $12 billion of operating cash flow in the past 6 months, up from $7.2 billion a year earlier. Management has a great track record for efficiency, meanwhile. Home Depot's return on invested capital (ROIC) is near 40% of sales compared to Lowe's 28% rate.
That success helps give Home Depot management flexibility to continue investing in the business, and buying back stock, during those frequent industry pullbacks.
3. The price is right
Home Depot's stock valuation reflects too much bearishness on Wall Street. Shares are now priced at below 2 times sales, down from 2.2 times sales at the start of the year. And yet Home Depot recently affirmed its 2023 growth and earnings outlook.
The valuation slump is just as clear when it comes to earnings. Home Depot's P/E ratio has declined to 18 from 21 it posted in early September.
These prices only make sense if you believe Home Depot won't recover from the current downturn to go on to set new sales and earnings records, as it has in all previous housing industry pullbacks.
For its part, management is confident in that rebound likelihood. The home improvement industry has several long-term tailwinds propelling it, including the demographic shift pushing more people toward home ownership and the age of housing stock.
As a leading consumer discretionary business, Home Depot would clearly benefit from the next bullish upturn in consumer spending.
But investors don't have to wait for clear signs that this rebound has started. They can take advantage of the current bearish attitude on Wall Street by purchasing the stock now, and simply holding through the volatility. Another bull market will arrive, and when it does, you'll be glad to have Home Depot in your portfolio.
