Is Home Depot a BUY?

Home Depot (NYSE:HD) and arch rival Lowes (NYSE:LOW) are seen as barometers of a housing market recovery.  The idea is simple and quite logical.  If homeowners remain concerned the value of their homes will continue to decline, they are less likely to invest in paint, fixtures, and other items to update and improve.  Home Depot reported Q2 results recently and the positive earning numbers drove the stock price up from around $52 to $56 where it remains today.  Revenues missed slightly, but investors didn’t seem to mind.

Analysts forecast earnings of $0.97 per share with revenue of $20.74 billion.  HD’s actual reported earnings were $1.01 per share with revenue of $20.6 billion.  One year ago the stock was trading at around $33 and it is now up about 80% to around $56.

So what is going on with Home Depot?  Is it overheated or is there still time to jump on right now?  Is this home improvement giant a BUY, a WAIT and SEE, or a STAY AWAY?

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework.

C = Catalyst for a Stock’s Movement

There are some rays of sunshine popping through the blackened skies of the US housing market but many investors remain unconvinced.  You can easily find a daily dose of negativity about the unresolved foreclosure crisis and uncertainty over things like the mortgage interest deduction.  You name it and if you are bearish you can find data to support your view.  Any improvement in the housing market that appears more sustainable and breaks through the current negative perception will be good for HD stock.

H = High Quality Pipeline

Home Depot long ago rolled out its proprietary brand name of Husky tools to compete with the Sears (NASDAQ:SHLD) Craftsman line.  Their lighting and kitchen and bath fixtures are constantly updated to reflect latest fashion trends.  They recently added three new additional appliance lines to their existing offerings — Whirlpool (NYSE:WHR), Electrolux and Frigidaire.

E = Equity to Debt Ratio is Close to Zero

Home Depot doesn’t fare very well on this metric with a debt to equity ratio of 0.60, or 60%.  MRQ (most recent quarter) figures show about $10.7 billion in debt with about $2.8 billion cash on hand.  Both total debt and cash on hand have been relatively constant over the last five quarters.  For added perspective, rival Lowes has a debt to equity ratio of .63, or 63%, with total debt of $9.6 billion and $3.2 billion cash on hand.

A = A Level Management Runs the Company

Home Depot’s star began to fade when both its entrepreneurial founders left the company.  Perhaps the most startling change was the complete collapse of one of the factors that made the company great – customer service.  Horror stories of customer woes flooded the Internet and Home Depot was slow to respond.  After several years of flailing about, the reins of the company were turned over to little known Frank Blake.  Blake took to social media to apologize for the company’s poor customer service and promised things would change.  Lowes had been eroding HD’s market share and Blake halted the decline and reversed the trend.  Many analysts attribute this impressive turnaround directly to Blake’s cost control measures and efforts to improve the customer perception of the company.

T = Technicals on the Stock Chart are Strong

In December of 2011 HD’s 20 day SMA (simple moving average) and 50 Day SMA crossed above the 200 Day SMA and has remained above ever since.  As of August 20, 2012 the share price was 7.69% above the 20 Day SMA; 8.7% above its 50 Day SMA; and 21.06% above its 200 Day SMA.

S = Support is Provided by Institutional Investors & Company Insiders

Home Depot is 75% institutionally owned.  Tthe top five holders are Capital Research Global Investors, Vanguard, State Street, BlackRock, and Capital World.  Insider transactions at 7.57% might worry some investors since transactions over the last six months show 9 sales of approximately 765k shares.  However, the sales were from high level officers and directors taking advantage of options exercises.

E = Earnings are Increasing Quarter over Quarter

HD’s EPS for the last five quarters were .87; .61; .51; .68 to the current $1.01.  However, in an environment that has been challenging to say the least, Home Depot has reported five consecutive quarters of increased same store sales.

E + Excellent Relative Performance versus Peers and Sector

Lowes (NYSE:LOW) followed HD’s earnings release and missed on every measure.  EPS was $0.64 versus estimates of $0.70 and revenues of $14. 25 billion missed estimates of $14.46 billion.  In addition they cut earnings estimates going forward while Home Deport raised its guidance to the top of the range.

Conclusion

Unless the country slips into the hotly debated double dip recession, Home Depot should continue to outperform as the housing recovery grinds on.  They are targeting international markets for growth but with a P/E of 20.19 and a share price that is already about 80% higher year over year there is some question about how much more the share price can appreciate until a full-throated economic recovery gets underway.  However, in January of 2012 some analysts felt HD was overvalued at $43, which of course did not prevent the shares from climbing higher to their current level of $56.  If you are a value investor, HD is a WAIT and SEE and a possible buy on the dips target.  Growth investors would be more likely to take the plunge and BUY in the belief the company will again exceed guidance for Q3 and the full year.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.

More from The Cheat Sheet