The Home Depot, Inc. (NYSE:HD) is up 40% in the last year, with many investors claiming that the home improvement retailer is well poised to benefit from a stronger housing market. In theory, Home Depot sees demand from several stages of the real estate transaction process: homeowners improve their house before selling, home buyers make purchases as part of customizing their new property, and people buying a house to “flip” it will sometimes fix up the house’s amenities or appearance on a large scale. Peer Lowe’s Companies, Inc. (NYSE:LOW), following similar logic, is up 23% in price since a year ago.
In the fiscal year ending early February 2013, The Home Depot, Inc. (NYSE:HD) reported a 6% increase in sales compared to the previous fiscal year largely on the back of 5% same store revenue growth. While the growth rate from the fourth fiscal quarter was 14%, this is partly explained by the quarter being 14 weeks instead of 13, so on a per-week basis revenue growth was in line with earlier in the year. Growth in operating expenses was held down with the result being 17% earnings growth for the year.
In its quarterly announcement The Home Depot, Inc. also announced that it would be increasing its dividend (the new yield is 2.2% at current prices) and announced that it plans to buy back $17 billion in shares over the next few years. There were $4 billion in share repurchases in the last fiscal year. The stock trades at 23 times trailing earnings, so even taking buybacks into account The Home Depot, Inc. (NYSE:HD) needs to deliver moderate earnings growth, but we would think even half as much earnings growth going forward as it did last year would be sufficient.
We track 13F filings from hedge funds and other notable investors as part of our work developing investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year. We can also use this database to see which top managers owned shares of Home Depot as of the end of December. According to our database, billionaire Ken Fisher’s Fisher Asset Management owned 8.3 million shares at the end of the fourth quarter (see Fisher’s stock picks) while Renaissance Technologies, founded by billionaire Jim Simons, reported a position of 1.8 million shares following a large increase in its stake (find more stocks Renaissance was buying).
Interestingly, Lowe’s has a similar valuation at a trailing P/E of 23. Its last quarter had one fewer week than the same period in the previous fiscal year; in total revenue was down 5% and earnings fell 11%, so even accounting for that its results were not as good as The Home Depot, Inc. (NYSE:HD)’s. Lowe’s is also active in repurchasing stock but judging from its financial performance it isn’t particularly attractive.
We can also compare The Home Depot, Inc. (NYSE:HD) to Lumber Liquidators Holdings Inc (NYSE:LL) and Sherwin-Williams Company (NYSE:SHW) since these companies sell flooring products and paint, respectively, which would also be in demand by home improvers. Sherwin-Williams trades at 28 times trailing earnings, but its revenue has been up and margins have been improving. Expectations of continued growth result in a forward P/E of 18. It’s also interesting that in general the company has relatively limited exposure to broader market indices with a beta of 0.6. Lumber Liquidators has risen 167% in the last year as it has been a huge beneficiary of the recovering housing market, though 19% of the outstanding shares are held short. It has the highest trailing P/E of the stocks we’ve discussed at 41, but revenue and earnings were both up over 20% in the fourth quarter of 2012 versus a year earlier.
With earnings growth higher at these two companies than the home improvement stores, they may be worth a closer look to see if they can sustain their growth enough to justify those higher valuations. In the case of The Home Depot, Inc. (NYSE:HD) the repurchasing program and same-store strength suggest that the company can sustain double-digit earnings growth rates for some time and if Sherwin-Williams and Lumber Liquidators don’t check out it could qualify as a “growth at a reasonable price” stock.
Disclosure: I own no shares of any stocks mentioned in this article.
