Shares of the home improvement retailer are rising when they seemingly shouldn’t be, further inflating an already-frothy valuation.
Are you thinking about buying Home Depot (HD 0.87%) stock? Interested investors are certainly facing something of a conundrum right now. Although shares may still be below their late-2021 pandemic-driven peak, they’re up 30% from October’s low as well. They’re also valued rather richly at a forward-looking price-to-earnings ratio (P/E) of 24. That’s well above this ticker’s long-term norm.
Is it too late to buy Home Depot stock?
If you’re a true long-term investor, no, it isn’t.
Home Depot is still waving red flags
To say the company’s sending mixed messages here is an understatement. Take last quarter’s numbers as an example. The top and bottom lines were both better than expected. Sales growth was tepid, however, and same-store sales actually fell 3.3% year over year. Per-share earnings of $4.67 topped estimates of $4.53 but fell for the sixth straight quarter.
HD Revenue (Quarterly) data by YCharts.
The home improvement retailer also dialed back its full-year earnings guidance. It’s now calling for a dip of between 1% and 3% compared to last year’s figure, with same-store sales likely to fall between 3% and 4% in 2024. The culprit for the weakness? No surprises here. CEO Ted Decker explains: “During the quarter, higher interest rates and greater macro-economic uncertainty pressured consumer demand more broadly, resulting in weaker spend across home improvement projects.”
Although interest rates may be inching lower, macroeconomic uncertainty remains palpable.
However, more often than not, stocks reflect their underlying company’s likely future more than its present. That’s why Home Depot shares have been far more bullish than bearish since logging a major low in October of last year despite lackluster quarterly reports in the meantime. The current economic challenges will eventually fade away, allowing this retailer to rekindle its usual strength.
The question is, given this stock’s relatively steep valuation, has the market gotten at least a little ahead of itself?
Probably not.
Better days ahead
Not everyone agrees with that argument, for the record. The analyst community’s current consensus price target stands at $381 per share, which is only 5% better than the stock’s present price. That’s not a great deal of constructive support.
Consumerism is predictably cyclical, even though many investors (as well as analysts) fail to predict rebounds until they become obvious. By then, it doesn’t matter much. The stocks that benefit from such economic revivals are often well into a major long-term advance, with too many people missing out on the early — and best — part of the opportunity. That’s why Home Depot shares have actually performed so well of late when they seemingly shouldn’t have. Investors are simply trying to sidestep this potential mistake.
The thing is, these buyers have good reason to be bold.
Take the housing market, for instance. Sales of existing homes as well as newly built homes are both still near multiyear lows reached just within the past couple of years. Higher interest rates and even higher home prices are keeping a lid on purchases.
Both are likely to recover soon, however.
See, the market’s betting on the equivalent of at least four quarter-point cuts to the federal funds rate between now and early next year, which will drag mortgage rates comparably lower. Although home values may or may not fall much by then, an outlook from Realtor.com suggests home-price increases should moderate from here thanks to growth in construction of single-family homes and a 14.5% increase in inventory of homes for sale.
Remodeling activity is on the verge of recovering as well. Harvard University’s Joint Center for Housing Studies suggests spending on remodels will continue to wane through early next year but then start leveling off en route to a recovery in the latter half of 2025. At the same time, while far from robust, sales of new homes are likely to begin perking up from here as well.
In other words, a big piece of Home Depot’s business that’s missing right now — building and remodeling — is poised for restoration soon.
Then, there’s the more generalized economic rebound that should boost Home Depot’s non-construction business. Although unemployment may now be inching higher while GDP growth cools, the Federal Reserve is still calling for GDP growth in 2025 and 2026 to more or less mirror this year’s muted-but-positive growth. Home Depot can gain market share even against a backdrop of tepid economic growth. Indeed, Bank of America analysts Robert Ohmen and Molly Baum recently penned: “While the macro remains choppy, we expect HD to see continued share gains as it accelerates growth and capabilities with the complex pro.”
Look where it’s going, not where it’s been
To be clear, Home Depot certainly isn’t the safest stock you can buy, nor the cheapest. It brings above-average risk to the table at an above-average valuation.
This is a case, however, where the retailer’s sheer size and subsequent transparency make it easy to make a judgment call on the company’s foreseeable future. Although it’s not exactly clear when we’ll start seeing more tailwinds than headwinds, the market correctly understands we’re likely to be seeing them sooner or later. It’s better to position yourself early for that rebound rather than waiting only to end up missing out. Stock prices tend to move on a forward-looking basis, after all.
More to the point (again), no, it’s not too late to buy Home Depot stock even if it is a bit expensive. It’s going to be able to grow its way into a fairer valuation soon enough.
