The Home Depot, Inc. (HD), founded in 1978, is the world’s leading home improvement specialty retailer. An Atlanta, Georgia-based company offers products and services for renovation, remodeling, maintenance, and home construction. The company has more than 2,245 stores in the USA as well as Canada, China, and Mexico, with more than 300,000 employees. The Home Depot’s stock is listed in Standard & Poor’s 500 indexes, and the Dow Jones industrial average.
As of Sept. 2, Home Depot stock was trading at $32 with a 52-week range of $28.13-39.38. It has a market cap of $49.2 billion. Trailing 12-month P/E ratio is 14.5, and forward P/E ratio is 11.7. P/B, P/S, and P/CF ratios stand at 2.7, 0.7, and 8.9, respectively. The 3-year annualized revenue and EPS growth stand at -4.2% and -4.0%, respectively. Operating margin is 9%, and net profit margin is 5.2%. The company has a low debt-to-equity ratio of 0.6. Home Depot has a yield of 3% for its shareholders.
Home Depot has a four-star rating from Morningstar. While its trailing P/E ratio is 14.5; it has a five-year average P/E ratio of 15.6. Out of 29 analysts covering the company, 15 have buy, two have outperform, 11 have hold, and one has outperform ratings. Wall Street has diverse opinions on Home Depot’s future. The bottom line is 0.4% growth, whereas the top-line growth estimate is 25.5% for the next year. Average five-year annualized growth forecast estimate is 13.2%.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Home Depot’s Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $2.24 along with the mean estimate of $2.70 for the next year.
E0 = EPS = ($2.24 + $2.70) / 2 = $2.47
Wall Street holds diversified opinions on Home Depot’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 13.2%. Book value per share is $11.45.
The rest is as follows:
Fair Value Estimator | ||
V0 | E0 | $2.47 |
V1 | E0 (1+g)/(1+r) | $2.52 |
V2 | E0((1+g)/(1+r))2 | $2.57 |
V3 | E0((1+g)/(1+r))3 | $2.62 |
V4 | E0((1+g)/(1+r))4 | $2.67 |
V5 | E0((1+g)/(1+r))5 | $2.72 |
D | E0(1+g)5/[r(1+r)5] | $24.77 |
BV | Equals | $11.45 |
Fair Value Range | Lower Boundary | $40.34 |
Upper Boundary | $51.79 | |
Potential | 61.86% | |
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my five-year discounted-earnings-plus-book-value model, the fair-value range for Home Depot is between $40.34 and $51.79 per share.
As of Sept. 3, Home Depot was trading at a price of $32. I like Home Depot as a company. The company offers its customers quality, value and innovation. I see great growth potential, as well. The market has under-priced Home Depot’s growth potential. The current price of $32 indicates the stock is undervalued. Based on my FED+ fair value estimate, Home Depot is 25% cheaper than the lower boundary of my fair-value range. The stock has 61.86% upside potential to reach the upper boundary of its fair value range.
O – Metrix Confirmation
If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:
O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5
- Dividend Yield: Higher is better.
- EPS Growth: Higher is better.
- P/E Ratio: Lower is better.
The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.
What is the O-Metrix Score?
- Home Depot has a yield of 3%. Therefore, the yield is 3.
- Growth estimate is the same as the discounted earnings model and is equal to 13.2%.
- Since we are at the middle of the year, taking the average of ttm (14.5) and forward (11.7) P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 13.1.
O-Metrix = [(13.2 + 3) / (13.1)] * 5 = 6.18
Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. Home Depot’s O-Metrix score of 6.18 is in the higher-than-average fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $32, the company is trading within the B-Grade, above-average-return zone.
Summary
Home Depot’s average P/E ratio in the last 5 years was 15.6. It is trading with a low P/E ratio of 14.5, and forward P/E ratio of 11.7. With a profit margin of 5.23%, Home Depot offered 3% dividend yield last year. The analysts’ average target price is $39.45, slightly lower than the lower-end of my fair value estimate. Its quarterly earnings growth was 20.58%. With a market cap of $49.2 billion, I expect the growth to keep its pace.
Its ttm return on equity of 19.1% is well-above the market. The ratio of year performance is 11%. In addition, the stock has a low total debt/equity ratio of 0.6 and Beta of 0.77. Home Depot stock has a lot of upside potential based on 13.2% EPS growth estimate. I would prefer this stock. It pays substantial dividends and priced with a low P/E ratio. I think the current price offers a profitable entry point.
