Meet a cyclical company that has turned itself into a reliable dividend stock.
Home Depot (HD -1.58%) is a top blue-chip dividend stock and a well-known home improvement leader. But the stock has cooled off.
As of late April, Home Depot stock was down over 20% from its peak. The stock is flat year to date compared to gains in the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average (Home Depot is one of 30 Dow components).
Let’s dive into Home Depot’s challenges, what to look for when it reports earnings on May 14 and its annual meeting of shareholders on May 16 —Â and why the stock remains a great buy now.
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Big bets despite slowing growth
Home Depot CEO Ted Decker called 2023 “a year of moderation” after blistering growth from 2020 to 2022. Periods of rapid growth followed by moderation or declines are par for the course. After all, Home Depot is a cyclical company heavily dependent on external factors like economic growth, macroeconomic conditions, consumer spending, etc.
The key is to ensure that a slowdown is happening for the right reasons (external) and doesn’t involve Home Depot losing its edge, failing to execute on strategic objectives, offering a declining customer experience, or some other internal blunder. Unfortunately, Home Depot’s own actions were partially to blame for last year’s weak performance.
The macroeconomic backdrop wasn’t easy, but Home Depot admitted it entered the year carrying too much inventory. It’s not making the same mistake for 2024.
Home Depot is reducing its fixed costs and passing along those savings to its frontline hourly associates with $1 billion in increased annual compensation. That investment is important as Home Depot expands its product offering — namely targeting professional contractors.
In November, Home Depot entered into an agreement to buy Construction Resources, a distributor that caters to professional contractors.
In late March, it announced the acquisition of SRS Distribution for a whopping $18.25 billion — including the company’s debt. The company is a massive distributor of building products and roofing materials.
Making a big bet during a period of slowing growth opens the door to uncertainty, which the stock market generally does not react well to. The timing of the acquisition could be a reason why the stock fell 13% in April.
Investing through the cycle
A big advantage for a large, financially strong company like Home Depot is that it can reinvest in the business and make improvements even during a cyclical slowdown. Home Depot opened 13 new stores in 2023. According to its June 2023 investor conference, it plans to open 80 new stores between 2023 and 2027. The company is making improvements to its online ordering and fulfillment and — as mentioned — targeting professional contractors in addition to consumers.
The best cyclical companies have a way of achieving higher lows and higher highs. In other words, each subsequent downturn isn’t as bad as prior slowdowns, and record gains are achieved during expansion periods. Limiting losses during a slowdown while capturing upside during an expansion is easier said than done. But Home Depot is doing that right before our eyes.
After taking into account the extra week in fiscal 2024 compared to fiscal 2023, Home Depot’s 2024 guidance calls for 1% lower sales and diluted EPS. So the stage is already set for a weak year. But not a down year.
When we think of a slowdown, it’s usually negative growth, not flat growth. In the company’s upcoming earnings release and annual meeting of shareholders, investors should listen for signs of how the slowdown is progressing, what Home Depot is doing about it, how it plans to integrate its recent acquisitions, and if these acquisitions can contribute to the bottom line and limit the damage of the slowdown. It’s also worth monitoring Home Depot’s continued emphasis on professionals and its e-commerce business.
A results-driven stock
There are plenty of reasons a stock can go up, such as investor optimism, faster growth, or better business prospects. But arguably the most justified increase in a stock is if earnings rise. If a business makes more money, it should be worth more. And that’s exactly what has happened to Home Depot.
Over the last five years, the stock is up 63%, and diluted earnings per share (EPS) are up 50%. Over the last decade, the stock price has also grown faster than earnings, but the dividend is up even more.
If a stock price and earnings are growing at roughly the same rate, the stock’s valuation from a price-to-earnings (P/E) ratio perspective should also be roughly the same. And sure enough, Home Depot’s current 23 P/E is nearly identical to its 10-year median P/E of 22.7.
Results-driven stocks can be a double-edged sword. If the company can grow earnings and the dividend over time, it will compound gains for shareholders. But when earnings stall, like they are for Home Depot right now, then the stock could also languish and underperform the broader market. This dynamic may keep some investors on the sidelines for the time being.
Home Depot is the perfect stock for patient investors
Investors shouldn’t expect Home Depot to skyrocket anytime soon. But the good news is that Home Depot is a great value, it has a sizable 2.7% dividend yield that pays patient investors to hold the stock, and it’s making the internal investments and acquisitions to sustain growth over the long term.
A quality dividend-paying company is able to raise its payout because of higher earnings. Even though its earnings have flatlined, Home Depot still has a payout ratio of just 55.4%. A healthy payout ratio leaves room to raise the dividend and shows that the expense is manageable.
The upcoming earnings release and annual meeting should provide excellent insight into the duration and severity of the slowdown. But ultimately, the long-term performance of Home Depot should continue to follow the trajectory of its earnings.
Home Depot is a no-brainer dividend stock to buy now. It has the brand power and market position to foster value, income, and growth for shareholders. But don’t be surprised if the stock remains under pressure in the short term.
