In late February, shareholders of the largest home improvement retailer, Home Depot ( HD -2.07% ), were rewarded with a 15.2% boost in the quarterly dividend to $1.90 per share. Despite this generous payout raise, shares of the stock have tumbled 23% year to date compared to the S&P 500‘s 5% decline during that time.

So should dividend growth investors buy Home Depot’s stock in the aftermath of its plunge in share price? Let’s dig into the stock’s fundamentals and valuation.

Another healthy quarter for the home improvement retailer

When Home Depot shared its fourth-quarter results for the period ended Jan. 30, it managed to beat analysts’ consensus estimates. The company reported $35.7 billion in net sales, up 10.7% over the year-ago period. This easily topped the average analyst estimate of $34.9 billion in revenue for the quarter. Home Depot’s total comparable sales (or comps) were up 8.1% year over year. 

So how did Home Depot surpass the analysts’ forecasts for the ninth quarter out of the past 10? President and Chief Operating Officer Ted Decker points to strength across the board. In his opening remarks in the recent earnings call, he said that all of its merchandise departments posted positive comps in the fourth quarter.

Image source: Getty Images.

This was in large part due to Home Depot’s leading market share among professional contractors, which account for most big-ticket comp transactions (i.e., those over $1,000). An 18% year-over-year increase in these transactions during the quarter helped to make up for the 3.8% decline in total comp transactions. 

On top of higher comparable sales, Home Depot also had more stores than a year ago. Store count increased 0.9% to 2,317 at the end of the fourth quarter.

Turning to the bottom line, Home Depot recorded $3.21 in diluted earnings per share (EPS) during the fourth quarter, representing a 21.1% year-over-year growth rate. This surpassed the average analyst prediction of $3.20 for the quarter, which was the ninth time out of the last 10 quarters that the company managed such a feat.

Aside from the higher net sales, earnings growth was the result of a couple of elements as well. First, the net margin increased 50 basis points year over year to 9.4% for the fourth quarter. Secondly, Home Depot’s weighted average share count fell 3.2% year over year to 1.04 billion in the quarter due to its share repurchase program.

Due to the economic reopening, Home Depot expects just slightly positive sales growth and low-single-digit diluted EPS growth in 2022. But because of the solid housing market, analysts are still expecting Home Depot to deliver 14.6% annual earnings growth over the next five years. 

The safest dividend is the one that was just raised

Home Depot’s great fourth quarter and decent medium-term growth outlook only partly explain its massive dividend hike. The stock’s dividend payout ratio seems to be the other part of the equation.

Home Depot’s dividend payout ratio was just 43% in 2021. For one, this provides the company with a buffer to maintain its payout if the economy were to experience a downturn. This also gives Home Depot the flexibility to continue with its share buybacks and acquisitions to drive diluted EPS higher.

Home Depot’s low-teens annual earnings growth potential and safe payout ratio should allow for at least low-double-digit annual dividend growth for the foreseeable future. And as the cherry on top, the stock currently boasts a market-topping 2.4% dividend yield. 

A discounted blue-chip dividend growth stock

Home Depot’s sell-off this year appears to have brought the stock’s valuation down from being somewhat rich to undervalued. For context, Home Depot’s forward price-to-earnings (P/E) ratio of 19.5 matches the S&P 500’s P/E ratio. A tremendous stock such as Home Depot deserves to be trading at a moderate premium to the market, in my opinion.

The stock’s trailing 12-month dividend yield of 2.2% is also slightly higher than the 13-year median of 2% — another indication that the stock is a buy for dividend growth investors.

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.