The recent price action for Home Depot (HD) helps demonstrate the virtue of patience in an often-turbulent market.
As an investor, I like the world’s largest home retailer. Nevertheless, a month ago, I was reluctant to add to my existing HD stake or to select the company for DTA’s Income Builder Portfolio.
Because I didn’t like the idea of buying Home Depot at 21 or 22 times forward earnings, which would have been the case with it priced near its all-time high of $215.
Concerns about the Federal Reserve’s interest-rate policy created a sell-off, however, and HD’s price has fallen back down to earth (as have the prices of hundreds of other high-quality stocks).
(Graph from Morningstar)
Thanks, Fed. And thanks, nervous sellers!
Nothing that occurred in the last month made Home Depot any less great of a company, so the price action was most welcome for buyers like me.
Not only did I add some shares to my own HD position, but I also decided to make Home Depot the 18th component in the IBP, the real-money Dividend Growth Investing portfolio funded by Daily Trade Alert.
On Friday, Oct. 19, the IBP added 6 shares at $179.79 apiece.
The portfolio will make one more October buy, either adding to a current position or initiating a stake in something new to the IBP.
About $916 remains from the $2,000/month that DTA provides, but the presence of a cash surplus in the account means we can go over $916 if we see fit.
Divvy Dollar Depot
There is much for investors to appreciate about Home Depot … and its rapidly growing dividend definitely deserves a big thumbs-up.
The company’s next dividend will be paid in mid-December, with the Income Builder Portfolio receiving $1.03 per share — or $6.18.
The IBP Business Plan mandates that all income produced gets invested right back into each company, so that $6.18 would buy about .034 of a share of Home Depot stock if the price is roughly the same as now.
Three months later, divvies would be paid on the new share total of 6.034 … and that’s not the only good news about the March 2019 dividend.
Home Depot is expected to announce an increased payout in February. A hike of only about 10% — well below its typical pace of growth — would lift the quarterly rate to $1.14, meaning the IBP would receive $6.88 in March. That, in turn, will buy still more HD shares.
Quarter after quarter, year after year, the income stream Home Depot produces will continue to grow. No wonder we named this project what we did!
Investors can rely upon Home Depot’s dividend, too. Simply Safe Dividends rates it “Very Safe,” with a score of 94 on a 1-100 scale.
The following graph from McLean Capital Research shows that Home Depot easily generates enough free cash flow to cover its dividend.
Analyze This!
On Wednesday, Oct. 17, HD was downgraded from Outperform to Neutral by Credit Suisse:
For HD, we downgrade our rating to Neutral, lowering our target price
to $204 from $222. We continue to view HD as best-in-class in retail, structurally one of our best positioned companies, with a superb management team. That said, we struggle to find multiple upside from this premium level as housing sentiment shifts and some uncertainty arises, while we see limited upside to comps and EPS. Key is upside from various strategic initiatives, expected to build over the next 3 years and where we could be too conservative. We lower FY18 EPS to $9.61 (from $9.67 vs. consensus at $9.56), and lower FY19 EPS to $10.17 (from $10.57). Our $204 target price is based on 20x our FY19 EPS.
Let me translate that a little. Even in issuing the downgrade, Credit Suisse still established a target price ($204) that was 10% higher than the previous day’s closing price ($185) — and 13% higher than what we paid.
Furthermore, CS acknowledged that Home Depot is “best in class,” well positioned and superbly managed. (And I concur.)
Also, even though Credit Suisse lowered its 2018 EPS projection to $9.61, that’s still higher than the $9.57 consensus of analysts.
This is exactly the kind of downgrade I like. The rationale for it wasn’t filled with especially bad news, and it might have helped push down HD’s price a little more right before I wanted to buy it. Thanks, Credit Suisse!
Otherwise, most analysts really like Home Depot. The following screenshot from Fidelity shows the bullishness of the analysts surveyed by Thomson Reuters:
Reuters’ survey of 35 analysts shows that the vast majority rate HD as either Buy or Outperform.
Valuation Station
Morningstar’s analysts assign Home Depot a fair value of $168, meaning they think it is slightly overvalued.
However, as the following Morningstar table illustrates, HD’s current and forward P/E ratios are well below the company’s 5-year average, the dividend yield is well above the norm, and the PEG ratio is a very reasonable 1.4.
Value Line, which includes Home Depot in its model portfolio of “Stocks with above-average year-ahead price potential,” gives HD a “Relative P/E ratio” of 1.09, making it just about fairly valued in their estimation.
VL’s target price range for Home Depot indicates they believe 55% appreciation over the next 3-5 years is achievable, and they just upgraded HD’s “Timeliness” rank to their top score of 1.
Timeliness measures the probable 6-12 month price performance of a stock relative to the approximately 1,700 other stocks covered by Value Line.
CFRA agrees that there is a lot of room for Home Depot’s price to run.
Schwab also expects future outstanding performance, giving HD an “Equity Rating” of B.
Finally, FAST Graphs indicates that HD is fairly priced relative to its historic valuation.
The following two illustrations show that Home Depot’s “blended P/E ratio” of 20.1 is right at its average for this millennium, and a little lower than its norm for this decade.
Wrapping Things Up
I had Home Depot on the Income Builder Portfolio watch list for months. As I waited patiently for a pullback, I tried to select other high-quality companies that were trading at better valuations.
The price we ultimately paid wasn’t a screaming bargain, but I’m very comfortable buying such a fantastic company at less than 18 times forward earnings.
I am due to make the next IBP selection in a week, with my article expected to run Oct. 27.
— Mike Nadel