It’s not surprising that Home Depot (HD -1.60%), with fiscal 2021 sales of $151.2 billion, benefits from a robust housing market. As home values rise, consumers are more inclined to take on renovation projects because they view these expenditures as an investment. And this supports demand for the company’s products and services.
But with mortgage rates increasing, the tailwind that benefited the business over the past couple years may be coming to an end. In the time after the Federal Reserve’s first rate hike (since 2018) in March, the average mortgage rate in the U.S. jumped to 5.1%, its highest level in more than a decade.
Does this foreshadow impending doom for the top retail stock? Here’s how rising interest rates could impact the company.
The importance of the housing market
“The customers’ mindset regarding their home is very straightforward,” Lowe’s CEO, Marvin Ellison, said last year. “As long as their home is increasing in value, they see upgrades and enhancements to their home as an investment and not an expense.” The same situation applies to Home Depot.
Therefore, it’s easy to understand how rising mortgage rates, which increase the cost to finance a home, can possibly be a headwind for the housing market by pressuring demand. And a basic understanding of economics teaches us that lower demand, all else equal, leads to lower prices. This could discourage consumers from taking on home renovation projects.
If we take a step back and zoom out, however, we’ll see that assuming Home Depot’s prospects are bleak going forward is a flawed perspective. While mortgage rates in this country have trended downward for the past four decades, there have been short periods of time when they’ve spiked. Home Depot’s revenue and profit have kept climbing higher, demonstrating its ability to perform well regardless of what interest rates are doing.
In the grand scheme of things, a mortgage rate of 5.1% is still low by historical standards. What’s more, data from Redfin shows that the median sale price of a home rose 17.3% year over year in March. Although this might not have fully baked in the higher mortgage rates, the number of homes for sale was down 16.8% compared to March 2021. Demand appears strong, and supply is under pressure, supporting a scenario where home prices keep rising.
For fiscal 2022, Home Depot’s management team expects sales growth to be slightly positive compared to the prior year. But this weak outlook has more to do with the extremely difficult comparison to a record 2021 than the macroeconomic environment. “The broader housing environment continues to be supportive of home improvement,” Richard McPhail, Home Depot’s CFO, highlighted on the company’s fourth-quarter 2021 earnings call.
Home Depot is a safe stock
There’s certainly a lot of uncertainty in the economy and stock market right now. The Federal Reserve’s tighter monetary policy is something we’re not accustomed to experiencing. But shareholders in Home Depot, a business that relies on the strength of the housing market, shouldn’t worry.
Home Depot has rewarded its investors with a 483% return over the past decade and a 1,500,000% return since going public in Sept. 1981. The company’s 17% share in a $900 billion market leaves a ton of room for continued growth. And perhaps most importantly, Home Depot operates in an industry that doesn’t invite much in the way of technological disruption.
Consequently, investors seeking a safe and reliable place to park their money should look no further than this stock. The shares trade at under 20 times trailing 12-month earnings per share, lower than the S&P 500‘s 24 multiple. And management just raised the dividend by 15%, resulting in an attractive yield of 2.2% as of May 3. Home Depot has now paid a dividend for 140 straight quarters.
Interest rates are set to continue their rise in the near term as the Fed tries to curb soaring inflation. While this has many people questioning what to do with their investments, owning Home Depot in a time of heightened uncertainty is the right move.