Over the past several decades, Home Depot (HD -0.11%) has grown into one of the world's largest retailers while generating life-changing investment returns for shareholders. Home Depot stock has turned a one-time $100 investment at its IPO into more than $3.6 million today.
The company's secret? It's a well-run business in a growing housing market. Home Depot has widely allocated its financial resources over the years, which, combined with steady sales growth, makes long-term investors very wealthy. The million-dollar question is whether Home Depot can still do the same for people who buy the stock today.
I crunched some numbers to find out and outlined the answer.
A best-in-class retail business in a massive market
Today, Home Depot is the world's largest home improvement retailer, with approximately 2,300 stores throughout North America. The company generates over $154 billion in annual sales. Its massive size and scale are a competitive advantage because it can source and sell products cheaper and deliver them faster than its smaller competitors. Plus, Home Depot's wide footprint means that most consumers live within a reasonable distance of a store.
But it wasn't always like this. Even Home Depot started small, and its rise to dominance wasn't an accident. The business has been well-run for decades, evidenced by a strong return on invested capital (ROIC) that has trended higher over time:
HD Return on Invested Capital (10y Median) data by YCharts
What does this mean? Home Depot's business is efficient; it earns a sizable return on each dollar it invests in the company. That can compound over time, and Home Depot's sales growth only amplifies that effect.
The result is rising cash profits, which Home Depot uses to pay a growing dividend and repurchase shares, further enhancing earnings growth and investment returns. Home Depot's share count has declined by 24% over the past decade, and its earnings per share have increased by 211%.
That's the magic formula.
Will it continue?
It's fair to wonder at some point whether Home Depot can continue its success as the company grows larger. Today, Home Depot carries a market cap of nearly $420 billion.
The company does still have growth opportunities. There's currently a housing shortage in the United States, estimated at approximately 4.5 million homes and counting. Home Depot sells to professionals (builders and contractors) and do-it-yourself consumers, so the company has exposure to new housing builds and renovation spending.
Additionally, the company acquired SRS Distribution for $18.25 billion earlier this year, a specialty distributor in the residential market, opening up Home Depot to new verticals like professional roofing, landscaping, and pool construction.
Home Depot estimates its total addressable market at $1 trillion, leaving plenty of room for expansion based on its $154 billion annual sales. That's a promising long-term prognosis, though investors should note that Home Depot is a cyclical business due to the ups and downs of the housing market and consumer spending trends.
Buying Home Depot today? Here's what to expect
While Home Depot still has growth ahead, it's probably unrealistic to expect the same returns the stock has given investors over the past few decades. Home Depot is a mature business, evidenced by its pivot to expand and acquire its way into new niches. Analysts expect Home Depot to grow earnings by an annual average of 9% to 10% over the next three to five years. Add in the stock's 2.1% dividend yield, and investors could see annualized total returns of 11% to 13%.
Low-double digit returns can compound very nicely, but it will take time. Home Depot is no longer a swing-for-the-fences investment.
Unfortunately, Home Depot's valuation may diminish those returns somewhat. The stock trades at a forward P/E of 28, which is high for a business anticipated to struggle to hit double-digit earnings growth. I don't think Home Depot, trading at a PEG ratio of 2.8, is so expensive that investors should sell the stock or avoid it altogether.
Still, Home Depot is a maturing, blue chip stock that has probably seen its best growth years. The company's high-quality fundamentals make it an excellent consideration for any diversified long-term portfolio, but will buying Home Depot today set you up for life? Probably not.
