With the Federal Reserve hiking interest rates to fight inflation, and economists raising the prospect of a recession, the stock market continues to be in a rough patch. The S&P 500 has fallen by 11% over the past year.
But long-term investors know that this type of market creates opportunities. Stock selection remains the key to creating wealth, however. It’s not easy finding high-quality companies.
Home Depot (HD -1.79%) has been a successful company for decades. With the share prices down 10% over the last year, they warrant a closer look.
A strong brand
Home Depot sells its goods and services to professional contractors and customers interested in doing their own work. The company also offers customers the ability to hire contractors for various services like installing flooring and cabinets.
With the highest sales among home improvement retailers, the company clearly has been a success. And it’s not a mature company, either. For the first nine months of fiscal 2022, which ended on Oct. 31, 2022, Home Depot’s sales grew by 5.3% to $121.6 billion, and comparable sales (comps) rose by 4.3%. And when many retailers have been confronting higher costs, Home Depot was able to expand its operating margin from 15.8% to 15.9%.
By contrast, competitor Lowe’s Companies saw its sales slip by 0.4% during the same period to $74.6 billion, and its operating margin dropped 2.3 percentage points to 11.3%.
While management expects a comps increase of 3% for the entire year, fiscal 2023 could prove challenging. The Federal Reserve remains vigilant in its fight against inflation, and economists predict sluggish gross domestic product growth. A recent survey of economists predicted a 70% chance of a recession.
The 30-year fixed mortgage rate is currently above 6%, much higher than a year ago when it was 3.56%. That’s likely a major factor in crimping home sales. For instance, existing home sales have fallen for 11 straight months, and December’s 4.02 million annualized units were 34% lower than a year ago, the slowest pace in a dozen years.
Since many people fix up their newly bought homes, a weaker housing market will undoubtedly hurt Home Depot’s sales. Additionally, if a recession with widespread job losses comes about, homeowners will put off major projects. For instance, during the major recession that lasted from late 2007 until mid-2009, Home Depot saw big sales declines. In the year that ended Jan. 31, 2010, comps fell by 6.6%.
While Home Depot’s business may face a temporary setback, investors needn’t fret too much.
That’s because they can continue relying on dividends. It has built a remarkable record of continuing payments through various economic cycles, paying for 143 straight quarters. Although the board of directors kept them constant from the last quarter of 2006 through the end of 2009, it has raised them annually since then. During that span, the quarterly dividend has gone from $0.225 to $1.90.
Barring a major recession, I would expect the board of directors to continue raising payments. And it has the free cash flow (FCF) to support them. For the first nine months of 2022. FCF was $7.8 billion, easily supporting the $5.9 billion of dividends. Home Depot has a 2.4% dividend yield.
Investors will find it virtually impossible to time stock purchases at the bottom of the market. But Home Depot, facing only one major competitor (Home Depot isn’t just larger than Lowe’s, but also generates higher sales per store), has a strong business that should continue propelling long-term sales and profitability growth. And, with its reliable dividend payment, you can wait out any near-term slump.
For those constructing a portfolio, Home Depot seems like a good place to build the foundation.
Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.