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ModernGraham Valuation: Home Depot (HD)

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Company Profile (obtained from Google Finance): The Home Depot, Inc. (The Home Depot) is a home improvement retailer. The Company operates The Home Depot stores, which are full-service, warehouse-style stores. The Home Depot stores sell an assortment of building materials, home improvement and lawn and garden products and provide a number of services. The Home Depot stores average approximately 104,000 square feet of enclosed space, with approximately 24,000 additional square feet of outside garden area. The Home Depot stores serve three primary customer groups: do-it-yourself (D-I-Y) customers, do-it-for-me (D-I-F-M) customers and professional customers. As of January 29, 2012, it had 2,252 The Home Depot stores located throughout the United States including the Commonwealth of Puerto Rico and the territories of the United States, Virgin Islands and Guam, Canada, China and Mexico. In October 2012, U.S. Home Systems, Inc. became an indirect wholly owned subsidiary of The Home Depot. In February 2013, it acquired Measurecomp LLC.

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor – must pass at least 6 of the following 7 tests: Score = 3/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
  3. Earnings Stability – positive earnings per share for at least 10 straight years – PASS
  4. Dividend Record – has paid a dividend for at least 10 straight years – PASS
  5. Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
  6. Moderate PEmg ratio – PEmg is less than 20 – FAIL
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL

Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
  3. Earnings Stability – positive earnings per share for at least 5 years – PASS
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – PASS

Valuation Summary (explanation of the ModernGraham valuation model):

MG Value $68.76
MG Opinion Overvalued
Value Based on 3% Growth $41.55
Value Based on 0% Growth $24.36
Market Implied Growth Rate 9.09%
NCAV -$6.84
PEmg 26.67
Current Ratio 1.30
PB Ratio 7.09

Key Data:

Balance Sheet – 8/4/2013 (an Introduction to the Balance Sheet)

Current Assets $16,895,000,000
Current Liabilities $12,995,000,000
Total Debt $11,450,000,000
Total Assets $42,192,000,000
Intangible Assets $1,170,000,000
Total Liabilities $26,714,000,000
Outstanding Shares 1,435,000,000

 

Earnings Per Share – Diluted

2013 (estimate) $3.6
2012 $3
2011 $2.47
2010 $2.01
2009 $1.55
2008 $1.37
2007 $2.27
2006 $2.79
2005 $2.72
2004 $2.26
2003 $1.88
2002 $1.29

Earnings Per Share – Modern Graham

2013 (estimate) $2.87
2012 $2.36
2011 $2.00
2010 $1.85
2009 $1.89
2008 $2.13

Conclusion:

Home Depot appears to be significantly overvalued at this time.  The company’s earnings on the surface seem to be improving the last few years, but when you look at the normalized earnings (EPSmg), there has been only a slight improvement over the longer historical period.  As a result, the growth rate the company has exhibited historically is much less than the 9% the market is implying.  In addition, the PEmg ratio is very high, along with the PB ratio, both of which also indicate the current price may be higher than the intrinsic value.  Finally, the company currently does not have a strong financial condition, having both a low current ratio and a low debt to net current assets ratio.  As a result, the company fails to fulfill the requirements of either the Defensive or Enterprising Investor.  Any investor considering making a purchase of Home Depot should do considerably further research.

What do you think?  Is Home Depot overvalued or does Mr. Market have it right?  Leave a comment or mention @ModernGraham on Twitter to discuss.

Disclaimer:  The author held a position in Home Depot at the time of publication.

Photo Credit:  Andrew Magill

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