Investors aren’t flocking to home improvement stocks today. With prices falling, interest rates soaring and a recession potentially looming, Wall Street has given up on the niche.
That said, the best returns accrue to investors who hold stocks through many economic cycles, which means now could be the perfect time to establish a position in a world-class retailer like Home deposit (HD -0.86%). Let’s take a closer look at whether the stock is a buy today or too risky to own.
The latest trends
The good news is that Home Depot has already seen some of the pain investors fear. Interest rates are rising and home sales have been slowing for some time now. We see the impact on the chain’s results, and it’s not devastating.
In fact, Home Depot in mid-August reported that second-quarter comparable store sales increased 6% on top of the 5% increase from the previous year. The chain has defeated its rival Lowe’s (DOWN -1.39%) in this department, in part due to its stronger position in the professional contractor niche. Do-it-yourself shoppers cut spending in the second quarter as inflation hurt their wallets. But Home Depot is still on track to increase sales again in 2022.
Profits and cash
Buying the stock today doesn’t mean you have to give up earnings growth in exchange for this increased revenue. Home Depot is finding ways to increase profitability despite soaring expenses. The rising operating margin seen in the chart is a good sign of pricing power and hints at other major competitive advantages.
Operating Margin (TTM) HD Data by YCharts
The company has other key financial selling points, including industry-leading return on invested capital and robust free cash flow. Management has directed much of its excess cash into stock buybacks, but Home Depot is also offering a more generous dividend payout of 55% of earnings compared to Lowe’s 35% target.
The way to go
The company had to suspend this payment of dividends during the worst of the financial crisis of the real estate crisis from 2009 to 2011. This painful period also included several years of declining sales and annual profits.
Still, Home Depot’s revenue has come out of this recession, rising from a low of $65 billion in 2010 to $151 billion last year. While few investors are predicting such a steep pullback today, it’s worth noting that shareholders have earned great returns simply by holding Home Depot stock during the volatility surrounding this major recession.
Price is another good reason to avoid waiting. Home Depot is valued today at about 1.8 times its annual sales, near its lowest valuation since 2016.
On the other hand, investors don’t have a clear picture of how Home Depot’s business will fare in an era of high and rising interest rates. This is the main reason to wait before buying the stock. And it’s a big one. Earnings and sales trends could be pressured for several years if home sales volumes fall too quickly.
This means that you may prefer to wait for Home Depot stock if your time horizon is less than a few years. Longer horizons increase the likelihood that you will profit from owning world-class companies despite periods of economic disruption. The Home Depot clearly fits that description, so investors who can see past the current volatility should have no problem keeping the stock in their portfolios.
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