Year to date, Home Depot‘s (NYSE:HD) stock has soared roughly 51% as a result of its marvelous business performance. This has absolutely trounced the S&P 500‘s 24.4% appreciation year to date, which raises the following question: Is Home Depot’s stock still a buy?
To answer this question, let’s go over three reasons to buy the stock and one reason you might want to consider selling it.
1. Home Depot torched third-quarter analyst estimates
Home Depot managed to easily beat analysts’ expectations of revenue and diluted earnings per share (EPS) in the third quarter ended Oct. 31.
The retailer reported $36.82 billion in sales during the quarter, representing a 9.8% increase compared to the year-ago period. This exceeded the average analyst forecast of $34.87 billion by 5.6%. How was Home Depot able to surpass the consensus revenue projection?
First, Home Depot increased its overall comparable-store sales by 6.1% year over year. This was the result of the fact that 12 out of Home Depot’s 14 merchandising departments posted positive comps during the quarter, according to COO Ted Decker’s opening remarks during the company’s Q3 2021 earnings call. Decker noted that the only two departments that didn’t grow comps were indoor garden (comps were basically flat) and lumber (comps were down by high single-digit percentages year over year for the department).
Second, Home Depot’s store count edged higher to 2,317 stores across U.S. states and territories, Canada, and Mexico.
Home Depot produced $3.92 in diluted EPS during the quarter, which works out to a robust 23.3% growth rate against the year-ago period. This helped the company to top analysts’ prediction of $3.41 in diluted EPS by 15%.
A year-over-year 100-basis-point increase in Home Depot’s net margins during the third quarter to 11.2%, paired with a 2.3% decline in the stock’s outstanding diluted share count, enabled the company to put together another highly profitable quarter.
The most encouraging figure from Home Depot’s third quarter was that its big-ticket transactions (defined as purchases $1,000 and up) were up 18% year over year. This is important because the vast majority of big-ticket transactions tend to come from professional contractors, which are the most lucrative customer base for home improvement retailers. This healthy growth suggests that Home Depot will remain the preferred destination of pros for the foreseeable future.
2. The balance sheet is a fortress
Home Depot’s operating results were once again spectacular in the third quarter. But an equally impressive reason to buy the stock is its strong financial positioning.
As of Q3, Home Depot’s net debt was $34.08 billion ($39.15 billion in long-term debt less $5.07 billion in cash). Over the last 12 months, Home Depot has generated $24.64 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA). This equates to a net debt-to-EBITDA ratio of 1.4.
This means that Home Depot could completely repay its long-term debt in about 17 months if it didn’t pay a dividend and income taxes. Of course, it will take longer because the company will continue to pay a dividend and income taxes. But the gist of it is that Home Depot maintains a conservative balance sheet. This should translate into a very low risk of bankruptcy in the long term.
3. A safe and market-beating dividend
The third reason to consider buying Home Depot is that the stock offers income investors a sustainable 1.6% dividend yield, which is moderately higher than the S&P 500’s 1.3% yield.
Because Home Depot’s payout ratio will be 42.7% for this year based on the average analyst estimate of $15.46 in diluted EPS, the stock has plenty of room to keep growing its dividend going forward.
Since analysts anticipate that Home Depot will grow its diluted EPS by 15% annually over the next five years, this should allow for double-digit percentage dividend increases in the medium term.
Home Depot’s stock has run up too far, too fast
Home Depot’s operating momentum and impeccable balance sheet haven’t gone unnoticed by Mr. Market, however. That explains why the stock has outperformed the broader market by such a wide margin.
As a result, I believe that the stock has appreciated too much in too short of a period of time. For instance, Home Depot’s forward P/E ratio of 25.2 is considerably higher than the S&P 500’s forward P/E ratio of 21.3. The stock undoubtedly deserves to be trading at a premium to the S&P 500, but I would argue the current 18% premium is a bit too much. That’s why I believe investors should put Home Depot on their watch list as one of the very first stocks to buy the next time the market experiences a pullback.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.