It's difficult to exactly time the market when considering whether to buy or sell a stock. Fortunately, stock traders with a long-term investment horizon don't need to put all that much emphasis on timing a stock decision. Long-term investors just need to do their stock-buying homework to better understand the business they might want to buy stock in. This research will help determine if a company's prospects are brightening or dimming. This type of homework is needed even for large, well-established companies.
Over several decades, Home Depot (HD -1.30%) has grown into a major home improvement retailer with a track record of strong performance for shareholders. Lately, however, Home Depot's stock is lagging the broader market. Over the past year, its total return of 10.7% is well below the S&P 500's comparable 25.7% total return.
Is this recent underperformance a warning signal to avoid Home Depot shares? Or is it a buying opportunity?
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Home Depot's performance is tied to the housing market
A check into Home Depot's business operations as well as a look at the broader economy suggests the underperformance is related more to the latter than the former. Elevated interest rates over the past two years have helped stagnate the housing market. There just aren't as many people buying existing homes and undertaking major renovations because it has become less affordable to do so. The interest rates are up to help get elevated inflation back under control. Inflation is falling but it remains somewhat elevated and it's leaving many consumers with less disposable cash to enact home repairs and renovations, creating another headwind for Home Depot.
Home sales have been falling of late, in part because home prices in many markets that Home Depot operates in are still high. Existing home sales in May fell 0.7% from the previous month and 2.8% compared to last year.
In its recent 10-Q report, Home Depot management specifically cited macroeconomic factors (including a shift in spending patterns among consumers and elevated interest rates) for the drop in same-store sales (comps). Total comparable sales in fiscal 2024's Q1 (ended April 28) fell 2.8%. Lower customer traffic accounted for 1.5 percentage points of that drop while less spending was blamed for the balance.
As long as interest rates remain elevated, it's unclear how soon the situation will change.
Home Depot maintains its enviable market share
Current investors can afford to be patient on Home Depot stock and wait out these short-term headwinds. One reason why is Home Depot's high market share. It opened its first store more than 40 years ago, and it has grown to become the world's largest home improvement retailer. Home Depot generated almost $153 billion in sales during fiscal 2023 (ended Jan. 28, 2024). That's much higher than its major competitor, Lowe's at $86.4 billion annually.
The company's sheer size helps it to achieve economies of scale and pass some of these savings on to customers. The rest it keeps, helping it earn a nice margin. Despite sluggish sales, Home Depot's gross margin rebounded in the latest quarter, increasing to 34.1% from 33.7% the previous year.
Home Depot is a dividend payer
Value investors holding Home Depot stock can also afford to be patient. While Home Depot's profit fell 7% year over year to $3.6 billion in the first quarter, it still generates plenty of free cash flow (FCF). Its first-quarter FCF was $4.7 billion. After reinvesting in the business, management looks to return cash to shareholders, including via dividends. Those dividends are not in danger.
The board of directors has raised dividend payments annually since 2010. That includes a 7.7% increase earlier this year. Home Depot has a 2.7% dividend yield, more than double the S&P 500's average of 1.3%.
The current headwinds are not a threat to the dividend continuing to grow. Even during the Great Recession, Home Depot managed to generate enough profit to keep its payout constant, even if it determined it was prudent not to raise the dividend during the worst of that time.
Home Depot presents a long-term opportunity
When making a decision about whether to buy, sell, or hold a stock, a multitude of factors come into play. One of the more common metrics used to help in evaluating whether a stock is a good buy is the stock's price-to-earnings ratio. Home Depot's shares currently trade roughly in line with its price-to-earnings (P/E) ratio average over the past decade.
HD PE Ratio data by YCharts
So buying the stock now based on that P/E metric wouldn't represent a bargain, but it also wouldn't be overpaying. Given Home Depot stock is up 307% over that same decade, it has some of the qualifications needed for consideration as a growth stock. And by growth stock standards, Home Depot's 22 P/E multiple is much lower than the S&P 500's average P/E of 29. That suggests it might just be a bargain buy right now.
Existing shareholders with a long-term investing mindset are likely best served by continuing to hold the shares, collecting the growing dividends, and waiting for the cyclical upturn. Long-term investors considering this stock will want to take a closer look. If Home Depot is holding up this well during a relatively low point in the economy, now has real potential to be a bargain time to buy and take advantage of Home Depot's long-term growth potential.
