With Tropical Storm Isaac still wreaking havoc on the United States, we thought we would analyze the world’s’ largest home improvement specialty retailer, Home Depot, Inc (HD), through the lens of FAST Graphs™.
About Home Depot Inc: Directly from their website
“The Home Depot is the world’s largest home improvement specialty retailer, with 2,255 retail stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, Guam, 10 Canadian provinces, Mexico and China. In fiscal 2011, The Home Depot had sales of $70.4 billion and earnings of $3.9 billion. The Company employs more than 300,000 associates. The Home Depot’s stock is traded on the New York Stock Exchange (NYSE: HD) and is included in the Dow Jones industrial average and Standard & Poor’s 500 index.”
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Earnings Determine Market Price: The following earnings and price correlated FAST Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
Earnings & Price Correlated Fundamentals-at-a-Glance
A quick glance at the historical earnings and price correlated FAST Graphs™ on Home Depot Inc shows a picture of overvaluation based upon the historical earnings growth rate of 11.8% and a current PE of 20.5. Analysts are forecasting the earnings growth to continue at about 15%, and when you look at the forecasting graph below, the stock appears overvalued, (it’s outside of the value corridor of the five orange lines – based on future growth).
Home Depot Inc: Historical Earnings, Price, Dividends and Normal PE Since 1998
Performance Table Home Depot Inc
The associated performance results with the earnings and price correlated graph, validates the principles regarding the two components of total return; capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.
When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 7.5% capital appreciation (green circle), long-term shareholders of Home Depot Inc, assuming an initial investment of $1,000, would have received an additional $360.52 in dividends (blue highlighting) that increased their total return from 7.5% to 8.4% per annum versus 3.9% (red circle) in the S&P 500.
The following graph plots the historically normal PE ratio (the dark blue line) in conjunction with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 1998.
A further indication of valuation can be seen by examining a company’s current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Home Depot Inc is 1.19 which is historically low.
Looking to the Future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1. The rate of change (growth rate) of the company’s earnings
2. The price or valuation you pay to buy those earnings
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.
The consensus of 30 leading analysts (light purple highlighting) reporting to Capital IQ forecast Home Depot Inc’s long-term earnings growth at 15% (orange circle). Home Depot Inc has medium long-term debt at 38% of capital (red circle). Home Depot Inc is currently trading at a P/E of 20.5, which is above the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Home Depot Inc’s True Worth™ valuation would be $88.15 at the end of 2017 (brown circle on EYE Chart), which would be a 10.6% annual rate of return from the current price (yellow highlighting).
Earnings Yield Estimates
Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Home Depot Inc to an equal investment in 10 year Treasury bonds, illustrates that Home Depot Inc’s expected earnings would be 6.5 (purple circle) times that of the 10 year T-Bond Interest. (See EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary & Conclusions
This report presented essential “fundamentals at a glance” illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it’s imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.
Disclosure: Long HD at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.