Is The Home Depot, Inc. (HD) A Smart Way to Play a Housing Recovery?

The Home Depot, Inc. (NYSE:HD) has been a popular pick among many investors looking for a large-cap stock with exposure to the boom in construction and housing sales (as sellers, house flippers, or buyers touch up housing properties before or after a transaction). In the last year The Home Depot, Inc. (NYSE:HD)’s stock is up close to 60%, more than doubling the return of the S&P 500. However, this increase in the price has been more anticipatory of future growth than it has been reflecting excellent results from the company; as a result, the stock’s trailing earnings multiple has increased to 25.

The first quarter of The Home Depot, Inc. (NYSE:HD)’s fiscal year ended in early May, with the company recording 7% revenue growth versus a year earlier. According to the 10-Q, this was primarily caused by same store sales growth of 4% (almost entirely due to larger customer spending per transaction). Net margins expanded with the result being that net income was up by 18%. While that’s a high earnings growth rate, we’d be concerned that it’s mostly come from higher net margins which is likely not a sustainable source of future increases in profits, and the valuation is high enough that The Home Depot, Inc. (NYSE:HD) would have to turn in similar growth rates for some time. Instead, it looks like current investors are dependent on sales numbers accelerating in future quarters, though they could be helped by the fact that cash flow from operations has been well above capex and management has been using this excess cash flow to buy back shares.

We can track interest in The Home Depot, Inc. (NYSE:HD) among hedge funds and other notable investors by consulting the same database of quarterly 13F filings which we use to help us develop investment strategies (for example, we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). According to these filings, billionaire Ken Fisher’s Fisher Asset Management owned 8.1 million shares of The Home Depot, Inc. (NYSE:HD) as of the end of March (find Fisher’s favorite stocks). Renaissance Technologies, founded by billionaire Jim Simons, increased its stake during Q1 to a total of 4.3 million shares (see Renaissance’s stock picks).

The closest peer for Home Depot is Lowe’s Companies, Inc. (NYSE:LOW). Markets are similarly optimistic about this home improvement store, as Lowe’s carries trailing and forward earnings multiples of 25 and 18 respectively (Home Depot’s forward P/E is 19). Lowe’s actually seems to have been doing fairly poorly recently, in comparison to Home Depot: there was little change in either revenue or earnings in its most recent quarter compared to the same period in the previous fiscal year. Its performance should probably converge to that of its larger peer, but we’d avoid it for now and take this as a sign of caution on the industry as a whole.