"Home Depot is el Cheapo."
That's a paraphrase from an avid Foolish reader describing his opinion of the product quality at home-improvement behemoth Home Depot
First off, Home Depot competes with another do-it-yourself giant named Lowe's
A stock versus a company
Home Depot's stock is down about 50% from its all-time high of just less than $70, back in December 1999 when its P/E was at an insane 56. Over the past five years, shares of Home Depot have lost close to 20%; in the same period, the S&P 500 has gained about 20%, and Lowe's is up around 70%. That doesn't instill a whole lot of confidence in the name, but Fools are well aware that a company's share price may not always move in the same direction as its overall performance. As a case in point, over that time frame, sales have grown 12.5% each year, while net income has advanced 18.2%. Return on capital has also improved each year, coming in at an impressive 20.7% for the last fiscal year.
Benjamin Graham famously described the stock market as a voting machine in the short term but a weighing machine in the longer term. Wall Street may be sour on Home Depot for now, but sooner or later, solid operating performance will duly reward investors with an upswing in the stock price.
Be patient with the large caps
Five years seems like a long time to suffer with underperformance, but Home Depot isn't much different from many other large-cap stocks, which have seen their lofty P/Es and other valuation multiples compress over the past five to seven years, despite robust operating performance. Large and successful firms such as Microsoft
Past versus future results
OK, the stock may look attractive based on past growth, but what about the future? It's hard to imagine significant growth from Home Depot, given its current annual revenues of $88 billion. The company already has 2,000 stores, averaging 105,000 square feet of inside store space and another 23,000 square feet of outside garden merchandise. Meanwhile, Lowe's has a 35% smaller store base, with roughly 1,300 stores, and operates in only half of the top 100 metropolitan markets. Given those numbers, further growth for Home Depot sounds nearly impossible.
The market is ginormous!
Not so fast. The domestic home-improvement industry is an approximately $700 billion market, encompassing $550 billion in DIY demand and another $150 million in labor and products for the do-it-for-me, or DIFM, market. Collectively, Home Depot and Lowe's account for only about 24% of the DIY market, and the Depot is aggressively moving into DIFM. In January, it bought Hughes Supply, a construction, repair, and maintenance supplier. As Lowe's keeps filling out its store base, Home Depot is snatching up the best of the DIFM market.
In other words, there's plenty of existing market share to grab. With Wal-Mart reporting total sales of about $330 billion over the past 12 months, Home Depot could still quadruple in size before it matched the 800-pound retail gorilla.
The Foolish bottom line
Future performance is no slam-dunk for either company. Both large firms rely on consumer sentiment and overall economic vitality. Rising interest rates may also cool off the housing market, denting growth prospects. But there are still plenty of home-improvement growth avenues to pursue, with home remodeling accounting for a good chunk of Home Depot's sales. In the meantime, the company's stock valuations aren't too expensive. Home Depot's prospects still look bright, but the best strategy may be to invest some investment funds both here and in Lowe's. The home-improvement market should still have more than enough room to grow.
Home Depot, Wal-Mart, and Microsoft are all Motley Fool Inside Value newsletter service recommendations. Johnson & Johnson is an Motley Fool Income Investor recommendation. Whatever your investing style, the Fool has a newsletter for you.
Fool contributor Ryan Fuhrmann is long shares of Home Depot but has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned further.