The Home Depot (HD 0.94%) hit an intraday and all-time high on Feb. 12 before pulling back with the rest of the market after a hotter-than-expected inflation print the following day.
Home Depot is one of the most well-known brands in home improvement. It's also an incredibly valuable dividend stock, with a market cap of $355.9 billion. -- making it the third-highest weighted component of the consumer discretionary sector.
Let's find out why such a well-known, massive company is still underrated after hitting an all-time high.
Image source: Getty Images.
Not as cyclical as you may think
Home Depot is in a cyclical industry in a cyclical sector affected by many cyclical factors, such as broader economic growth, consumer spending, interest rates, construction costs, and the housing market. Yet Home Depot's earnings aren't nearly as volatile as pure-play homebuilders like D.R. Horton, Lennar, and Toll Brothers, among others. Home Depot is affected by commodity prices and raw material costs but not in the same way oil and gas producers are heavily impacted by oil and gas prices.
Since 2010, Home Depot's earnings have steadily climbed (for the most part). This chart shows Home Depot's stock price, net income, and the Case-Shiller Home Price Index over the last 20 years. The index tracks the average prices of residential real estate in the U.S.
HD data by YCharts. TTM = trailing 12 months.
After the financial crisis of 2008, the housing market began to rebound, essentially shooting straight up from the early 2010s to the COVID-19 pandemic of 2020. Over the last four years, the Case-Shiller Home Price Index has surged a staggering 45.6%. Over the last 10 years, it is up 92.2% -- which has had a major impact on the broader economy and home affordability.
The secret to Home Depot's consistency is that its business model can do well at different points in the business cycle. When interest rates and housing prices are high, folks may choose to improve an existing home instead of buying a new one. When housing prices are high but interest rates are low, consumers may choose to refinance. When consumer spending is low, people may put off home improvement projects.
But overall, the dips Home Depot has seen in its sales and earnings have been relatively minor. That's because the company has done an incredible job managing its supply chain, predicting consumer trends, and fulfilling buyer needs.
Maintaining financial health
Home Depot isn't entirely without its risks. A complete collapse in the housing market and a widespread recession would certainly tank its sales. That's why Home Depot's balance sheet is so important.
I'm not totally in love with Home Depot's balance sheet, namely because its total net long-term debt position continues to climb. But there are valid reasons for this.
HD Net Total Long Term Debt (Quarterly) data by YCharts. EBIT = earnings before interest and taxes. TTM = trailing 12 months.
Home Depot has an incredibly strong interest coverage ratio, which is earnings before interest and taxes (EBIT) divided by the interest expense. The ratio basically tells you whether the company's earnings are strong enough to afford the interest on its debt. In the case of Home Depot, its EBIT is 13.1 times its interest expense, which is an excellent ratio.
Home Depot's debt has been climbing mainly because the business has gotten so much bigger. The expansion has paid off. As you can see, Home Depot has done a good job expanding its operating margin while also growing sales and earnings.
Rewarding shareholders with a sizable capital return program
Home Depot could easily have zero net debt on its balance sheet if it weren't growing its dividend and buying back a boatload of its own stock. But Home Depot's capital return program has proven immensely valuable for shareholders. Since the debt is manageable, it's OK that Home Depot is buying back stock and rapidly raising the dividend.
Since Home Depot began paying a dividend in 1987, it has raised its dividend every year, except for a pause between 2008 and 2009 (for obvious reasons). Over the last decade, Home Depot's dividend has more than quadrupled, while its outstanding share count is down 28%, thanks to buybacks.
HD Shares Outstanding data by YCharts.
This is the exact kind of chart you want to see from a growing dividend stock, especially if the stock price is going up, as that means buybacks were a good use of capital. In sum, Home Depot's balance sheet is in good shape and could be perfect if it wanted to cut back on buybacks.
Home Depot is worth buying now
Home Depot is a well-run, industry-leading business with solid fundamentals. The stock yields 2.3%, not because of a lack of dividend raises but because the stock price has outpaced the rate at which Home Depot has been able to grow the dividend. Buybacks have helped boost earnings per share to keep the stock at a good value. In fact, Home Depot sports a 23 price-to-earnings ratio, which is solid, considering how much the stock has run up.
Home Depot's historic results prove it is a far more consistent company during economic cycles than it is given credit for. A big part of that has been the resilience of the housing market. For investors who think the housing market will continue to be strong, Home Depot is worth a closer look, even as the stock hovers around its all-time high.
