October 06, 2011 at 09:36 AM EDT
Should You Buy the Dow — Home Depot
Home Depot has a heavy reliance on one of the weakest markets out there -- housing. Still, HD has persevered and presents an investing bargain today.

Should You Buy the DowToday, the company under the microscope is Home Depot (NYSE:HD). Like many gigantic companies that have been around for awhile, I regard Home Depot as a stalwart. In other words, it’s still growing at a solid, modest and dependable rate of under 10%, but more than 5% to 6%.

Like all companies in this series, I’m also delving into all aspects of their business because I’ve found a lot of companies have surprising breadth. In this case, however, Home Depot is what we all think it is: It sells building materials, home improvement products, and lawn and garden products. It installs carpeting, flooring, cabinets, countertops, water heaters and other large systems. What might surprise you is its scale — it has 2,245 stores, including a few in Canada, Mexico and China.

Home Depot has a major drawback, however. It is very sensitive to the economy, particularly housing. When the housing market started to collapse in 2006, Home Depot’s earnings fell by 60% through 2008. From a price just more than $40 a share on Jan. 1, 2006, the stock hit $18.51 in October 2008. The good news is private investors have swooped into the distressed housing market and are buying, rehabbing and flipping houses in various markets across the country. That means more business for Home Depot. Indeed, analysts are looking for another 16% this year and 14% next year, along with five-year annualized growth of 13.5%. Stalwart? Nuh-uh. Growth company. Still.

How are the company’s financials following the housing crash? Things look fine. The company carries $2.55 billion in cash against $10.73 billion in debt. Total debt service is at a blended rate of about 5.6%. That’s cheap debt, especially considering trailing 12-month free cash flow is $4.45 billion. That’s also nearly three times what’s needed to pay the company’s 3% dividend yield.

Conclusion

With a 13.5 P/E on projected 2015 earnings of $4.23 per share, including reinvested dividends, we get a price target of $57. That’s about an 80% total return from here, and the company trades right at a 14 P/E. With the growth rate mentioned above, that suggests to me that Home Depot is fairly valued at today’s price. That means you aren’t overpaying. In fact, a company as solid as this probably is deserving of a premium multiple. So you might even be getting a slight bargain. It would be totally reasonable to expect a 15% total return annually going forward, including dividends.

  • I believe Home Depot is a buy for regular accounts.
  • I believe Home Depot is a buy for retirement accounts.

Disclosure: Lawrence Meyers does not own shares of Home Depot.


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