Home Depot Looks Overvalued After 80% Gains

After an 80% rise since the March lows of this year, at the current price of around $270 per share, we believe Home Depot’s stock (NYSE: HD) has reached its near term potential. The home improvement retailer has seen its stock outperform through the coronavirus crisis, rising by almost 27% year-to-date (compared to a 2% growth in the S&P), benefiting from the stay-at-home bump. Home Depot’s stock is already about 54% higher than it was at the end of 2017. Our dashboard, What Factors Drove 54% Change in Home Depot Stock Between 2017 and Now?, provides the key numbers behind our thinking, and we explain more below.

Some of this growth over the last few years is justified by the roughly 9% increase in Home Depot’s revenues from $100.9 billion in 2017 to $110.2 billion in 2019. In addition, earnings growth, on a per-share basis, was higher by 40%. This was driven by a 160 bps net margin expansion from 8.6% to 10.2% and a 7% decline in shares outstanding during this period.

Finally, Home Depot’s P/E ratio grew from about 24x at the end of 2017 to 26x currently. The company’s P/E Multiple is yet to see a meaningful decline from the current 26x levels, which still remains 27% higher than the levels of 21x seen in 2019. We believe that the stock could remain rangebound around the current levels in the near term.

So how has Coronavirus impacted the stock?

Home Depot has remained open as an essential retailer during the pandemic restrictions and has benefited from home improvement projects. In its most recent quarter ended Aug 2, Home Depot reported revenue of $38 billion, an increase of 23% year-over-year, the retailer’s largest quarter of growth since 2002. The surge in sales helped grow net earnings to $4.3 billion in Q2, compared to $3.5 billion in the same quarter a year ago. In addition, the company also reported a comparable sales growth of 23.4%. This compares to full-year fiscal 2019 comparable sales growth of 3.5% and Q1 2020 comparable sales of 6.4%.

It should also be noted that Home Depot is in the midst of an $11 billion multiyear investment to upgrade its capabilities. The company is already benefiting by investing in technology within its stores to improve its supply chain and e-commerce shopping experience. In Q2, the retailer’s digital sales increased by approximately 100% with customers picking up 60% of those orders in-store.

Going forward, we believe the recent boost in sales might only be short-lived. As to-do items get checked off, customers are likely to decrease these spending levels in the coming quarters. This could likely be a result of a rise in unemployment and lower consumer sentiment, and its potential impact on holiday sales.

What if you’re looking for a more balanced portfolio instead? Here’s a high quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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