Will Home Depot Remain One of the Dow's Best Stocks in 2014?

It's been slightly more than four-and-a-half years since the Dow Jones Industrial Average (^DJI 0.56%) bottomed out in the spring of 2009. Since the index's lowest ebb, its overseers have replaced six components, and the Dow has surged from below 7,000 points to more than 16,000 points for the first time in its history. Due to the index's price-weighting structure, some stocks have had a far greater impact on that rise than others -- and few have had a bigger effect than Home Depot (HD 0.74%) which has been the Dow's best-performing nonfinancial component from the day the market's rebound began:

HD Total Return Price data by YCharts.

It's been a great streak for Home Depot shareholders, who have enjoyed a modest but undeniable rebound in the American housing market in recent years, but savvy investors would rather look forward to the gains yet to come than dwell on the gains they've already known. Will the world's largest home improvement retailer thrive in 2014 as it has in 2013, or are the winds of change beginning to blow against it again?

The year ahead: by the numbers
Home Depot's earned its gains over the past few years, as its bottom line has surged higher at an impressive rate for such a massive retailer:

Sources: Morningstar and company press releases.
* 2013 EPS result and growth rate are based on Home Depot's latest estimates.

Home Depot released updated guidance for the upcoming 2014 fiscal year just this morning, and its projected 17% earnings-per-share growth above its anticipated 2013 earnings shows the company taking a cautious tack. However, its nothing to sneeze at, especially given Home Depot's strategy of underpromising and overdelivering -- its earliest guidance for fiscal 2013 was for EPS growth of just 12% from the 2012 fiscal year. With final guidance now set at twice that level, it's possible we could see 2014 produce a smashing 34% EPS growth rate, which would result in $4.98 in final earnings per share for the upcoming year.

Will Home Depot trounce its initial guidance once again? Analysts currently expect an 18% growth rate for the coming year, which is somewhat weaker than what they project for competitor Lowe's (a 22% growth rate), for large homebuilders Toll Brothers (TOL -0.84%) (a 48% growth rate) and Lennar (a 22% growth rate), for paint maker Sherwin-Williams (SHW -1.10%) (a 20% growth rate), or for smaller home-improvement specialist Lumber Liquidators (LL) (a 28% growth rate). Despite lower expectations -- which would still nevertheless be quite strong for any retailer or housing-related stock close to Home Depot's size -- the company still boasts a modestly elevated valuation, which is neck-and-neck with Lowe's and only significantly behind the two specialty retailers we've just examined:

HD P/E Ratio (TTM) data by YCharts.

However, of the four of these companies that have been profitable since the day the rebound began -- homebuilders have had a rough road back to profit after engaging in massive overbuilding during the subprime bubble -- Home Depot has experienced by far the least growth in its valuation:

HD P/E Ratio (TTM) data by YCharts.

This is a rather positive sign for Home Depot shareholders, who have far less to fear from their favorite housing-sector stock's valuation returning to a long-range average than do shareholders in other housing-related stocks. However, the threat of a taper in the Federal Reserve's quantitative easing effort -- widely believed to be in the cards for 2014 now that the unemployment rate has reached former Chairman Ben Bernanke's 7% target for ending the stimulus program -- could crimp growth throughout the housing sector by raising rock-bottom interest rates before once-bitten lenders get over their shyness toward the mortgage market. In fact, Home Depot's relatively steady share-price growth abruptly halted as soon as Bernanke began talking about tapering at the Fed's June press conference. Since that day, Home Depot's shares have lost roughly 2% even as the Dow itself has grown another 6%.

If and when the Fed winds down its asset-purchasing program, Home Depot shareholders may wind up with far more modest gains than they've been used to for the past four years. However, moderation of the red-hot growth in housing stocks is likely to have a more muted impact on Home Depot than it will on many others in the sector, due to its superior size and more stable long-term valuation. For long-term shareholders, Home Depot is likely to remain one of the best housing stocks on the market, even if its extended streak of beating the Dow comes to an end next year.