The Home Depot, Inc. (NYSE:HD) has been a popular pick among many investors looking for a large-cap stock with exposure to the boom in construction and housing sales (as sellers, house flippers, or buyers touch up housing properties before or after a transaction). In the last year The Home Depot, Inc. (NYSE:HD)’s stock is up close to 60%, more than doubling the return of the S&P 500. However, this increase in the price has been more anticipatory of future growth than it has been reflecting excellent results from the company; as a result, the stock’s trailing earnings multiple has increased to 25.
The first quarter of The Home Depot, Inc. (NYSE:HD)’s fiscal year ended in early May, with the company recording 7% revenue growth versus a year earlier. According to the 10-Q, this was primarily caused by same store sales growth of 4% (almost entirely due to larger customer spending per transaction). Net margins expanded with the result being that net income was up by 18%. While that’s a high earnings growth rate, we’d be concerned that it’s mostly come from higher net margins which is likely not a sustainable source of future increases in profits, and the valuation is high enough that The Home Depot, Inc. (NYSE:HD) would have to turn in similar growth rates for some time. Instead, it looks like current investors are dependent on sales numbers accelerating in future quarters, though they could be helped by the fact that cash flow from operations has been well above capex and management has been using this excess cash flow to buy back shares.
The closest peer for Home Depot is Lowe’s Companies, Inc. (NYSE:LOW). Markets are similarly optimistic about this home improvement store, as Lowe’s carries trailing and forward earnings multiples of 25 and 18 respectively (Home Depot’s forward P/E is 19). Lowe’s actually seems to have been doing fairly poorly recently, in comparison to Home Depot: there was little change in either revenue or earnings in its most recent quarter compared to the same period in the previous fiscal year. Its performance should probably converge to that of its larger peer, but we’d avoid it for now and take this as a sign of caution on the industry as a whole.
Home Depot can also be compared to Lumber Liquidators Holdings Inc (NYSE:LL), which provides flooring materials for homes, and paint and finish manufacturer and retailer Sherwin-Williams Company (NYSE:SHW). The smaller Lumber Liquidators (its market cap is only $2.4 billion) has been an even stronger performer than Home Depot over the last year, rising about 150%. However, this has placed its valuation at 30 times consensus earnings for 2014 and the most recent data show 24% of the float held short as many market players are skeptical of the company. Sherwin-Williams also has a good deal of future growth incorporated into the stock price; for example, its forward P/E is 17, essentially in line with the home improvement stores. Similarly to Home Depot, its earnings have been up considerably but revenue growth has been much more limited, and so it looks a bit speculative in value terms at its current pricing.
Home Depot (and Sherwin-Williams) seem to be in a better position than Lowe’s in terms of their recent financial performance. However, even in those cases revenue growth has been fairly low considering that their valuations are high enough that the companies would have to deliver strong earnings growth for a period of years. As a result neither of the two looks like a cheap way to play housing at this point.
Disclosure: I own no shares of any stocks mentioned in this article.
