We’re Buying This Stock on Friday, October 19

Last week was when I was supposed to have written this article about the next company to join DTA’s Income Builder Portfolio.

Life intervened, however, as I was summoned to serve jury duty in federal court in Charlotte.

Our case involved a U.S. Army reservist accused of operating a prostitution ring, and we ended up finding him guilty on 7 of 9 counts.

Once the trial ended, I was able to turn my attention from sex trafficking to investing … and from the “world’s oldest profession” to the world’s largest home improvement retailer.

Yes, the IBP’s 18th position will be Home Depot (HD); on Friday, Oct. 19, I will execute a buy order on Daily Trade Alert’s behalf for about $1,000 of HD stock.

Market Mayhem

This selection comes amidst an interesting time for investors.

Two consecutive sessions last week featured major market pullbacks, and the S&P 500 Index fell about 5.6% during the first half of October.

Over the same span, the Income Builder Portfolio declined less than 2%, continuing its market-beating performance.

Some investors worry that the recent volatility is a sign of an imminent market crash.

I can’t pretend to know whether the next recession will begin tomorrow, or thousands of tomorrows from now … and neither can anybody else.

Back in 2012 and 2013, many pundits saw doom lurking right around the corner … and yet here we are, more than halfway through Year 10 of one of the strongest bull markets ever.

Dependable Depot

Because none of us has a magic crystal ball, I have tried to fill the IBP with some of the highest-quality, most-proven, name-brand companies available … and Home Depot certainly fits that description.

Over the last decade, few retailers have come close to matching the performance of HD, which has more than quadrupled the gain of the S&P 500.

(Data from TickerTech.com; graphic from DividendChannel.com)

This “Financial Sonar” from Jefferson Research indicates the consistent strength of Home Depot’s operations:

As impressive as HD’s history has been, it’s the future that really matter to investors.

This slide, taken from the company’s May update of its 2020 Long-Range Financial Targets, shows the ranges HD expects for sales, operating margins and return on invested capital:

Home Depot has consistently outperformed rival Lowe’s (LOW) over the years, and it figures to stand up well to the likes of Amazon (AMZN) and other e-retailers.

Morningstar’s analysts, who applaud the company’s wide economic moat and “exemplary” management, say this about HD’s ability to outpace the competition:

Home improvement retailers remain one of the best-insulated sectors from e-commerce threats, as the high weight/value ratio of many products prohibit cost-effective shipping and the specialized knowledge base employees offer is difficult to replicate.

Contractors, who shop at Home Depot in droves, do not order lumber, plasterboard, toilets, hot water heaters, HVAC equipment and other major supplies from Amazon.

The same is true of Joe Handyman, who needs to fix that leaky faucet or crumbling grout RIGHT NOW, so he makes a quick run to his local HD for the parts he needs.

(I actually shouldn’t have been so sexist in my last paragraph. I was about to call the plumber a few months back but my wife insisted that she could fix the toilet — and, with a little help from Home Depot, she did!)

Risky Business?

Home Depot benefits directly from a healthy housing market and overall economy.

As house prices go up, many homeowners opt to stay put and do improvement projects. Furthermore, those who do move often want to upgrade their new residences.

So it’s not too surprising that housing downturns are probably the biggest risks to HD and similar retailers.

During the Great Recession, when the housing market tanked, HD matched SPY’s 56% decline.

While that could give nervous investors cause for pause, HD did recover quickly and strongly.

The following FAST Graphs illustration shows that the company followed three years of earnings declines with five years of 20%-plus EPS growth:

Dividend Depot

Even though earnings and free cash flow took a hit during the recession, Home Depot’s board — unlike directors at some companies — did not cut the dividend. Nevertheless, HD did freeze the payout at 90 cents for the next three years.

A modest 5% raise was announced for 2010 … and then the Divvy Dollar Dynamite really began exploding.

The payout to shareholders has more than tripled over the last half-dozen years, and HD has become more and more attractive to Dividend Growth Investing practitioners. I have owned it in my personal portfolio since February 2017.

Despite the major advance in the company’s stock price, HD’s 2.1% yield is a 7-year high.

In presenting Home Depot’s 15.7% increase back in February, CEO Craig Menear said:

As a testament to our commitment to create value for our shareholders and our positive outlook for the business, the board has increased the dividend for the ninth consecutive year. … This is the 124th consecutive quarter the company has paid a cash dividend.

I love wide-moat companies with decades-long commitments to creating value for shareholders through dividends. Such a history strongly suggests years and years of income growth to come from Home Depot.

HD is due to announce its next hike in February. And with forecasts calling for 29% EPS growth and 18% higher free cash flow in 2019, I’d be surprised if we didn’t get another big raise.

Wrapping Things Up

Home Depot is not the perfect stock for every investor. Those most concerned with preserving capital might fear a big price drop during the next recession due to HD’s close relationship to the housing market and overall economy.

However, for long-term investors who want the best brands, and for DGI proponents who crave reliable, growing dividends, Home Depot is quite an attractive choice.

I certainly think it fits in nicely with the 17 other companies in the Income Builder Portfolio.

My article about the execution of our HD purchase, along with some pertinent valuation information, will be published Saturday, Oct. 20.

As always, I strongly recommend that investors conduct their own due diligence.

— Mike Nadel