For retail investors it can make sense to look at what highly successful investors with a strong track record are purchasing. This allows retail investors to find out what quality metrics are important when it comes to stock picking, which, in turn, allows them to emulate investing strategies that have proven to be successful.
One of the investors whose stock picks are widely followed is Kevin O’Leary, the chairman of O’Shares Investments, and a member of the hit show Shark Tank. The O’Shares FTSE U.S. Quality Dividend ETF allows investors to invest into high-quality income stocks through a diversified portfolio, but investors can also look at the holdings of this ETF if they want to be more active stock pickers.
In this article we will focus on one of the top Kevin O’Leary dividend stocks of this ETF, Home Depot (HD).
Home Depot is the largest home improvement retailer in the United States, and thanks to its quite large size, with a market capitalization of $211 billion, Home Depot is also a member of the Dow Jones Industrial Index. Home Depot was founded in 1978, and has turned into a major blue chip stock since then. The US home improvement retail market is not fragmented, it is more or less controlled by Home Depot and its smaller peer Lowe’s (ticker: LOW), which is roughly half as large as Home Depot in terms of market capitalization.
Source: Home Depot presentation
Home Depot operates roughly 2,300 stores across the US, in Canada, and in Mexico, which generate a total of $110 billion in annual revenues. The large majority of Home Depot’s stores are located in the United States, which reduces Home Depot’s foreign currency exposure to a minimum.
Recent Earnings Results And Growth Prospects
Home Depot has announced its most recent quarterly results on February 26. During the fourth quarter the company generated revenues of $26.5 billion during the quarter, which was 10.9% more than what the analyst community had expected. One should note that revenues were positively impacted by a fourteenth week during the quarter, whereas Q4 of 2017 only had 13 weeks. The most recent quarterly results continue a strong revenue growth track record that was maintained throughout the last couple of years, driven primarily by rising comparable store sales. Home Depot does not open a large amount of new stores, thus revenues primarily rise due to higher revenues at its existing stores, and due to rising sales of its e-commerce business.
During the fourth quarter same store sales rose 3.2% year over year, which was slightly less than the 5.2% comparable store sales that Home Depot has delivered during fiscal 2018 as a whole. Home Depot generated earnings-per-share of $2.25 during the fourth quarter, which was 33% more than the earnings-per-share that Home Depot has generated during the previous year’s fourth quarter.
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Due to the fact that Home Depot does not open a large amount of new stores, its revenues will grow relatively in line with its comparable store sales in the long run. This is enough to generate meaningful sales growth, though, and earnings-per-share growth will grow at an even higher rate, thanks to several factors that play a role. First, rising comparable store sales allow for operating margin gains, as fixed costs do not rise, while gross profits are improving. The operating leverage that results from this has been a relevant driver of Home Depot’s earnings in the past, and the same should be true going forward. Consumer spending continues to rise, and due to a strong economy and low unemployment it is unlikely that this will change in the near term. This means that Home Depot does not only profit from building activity across the US, but also from consumers purchasing at Home Depot for renovations, remodeling, upgrades, etc.
Home Depot’s profits will also be enhanced by management’s goals of improving the company’s efficiency, through measures such as optimizing the supply chain and inventory levels. Last but not least, Home Depot’s earnings-per-share are further positively impacted by share repurchases. These have lowered Home Depot’s share count from 1.7 billion to 1.1 billion over the last decade, and management plans to keep up with buybacks going forward. During the most recent earnings call, Home Depot has announced a new $15 billion share repurchase authorization, which could lower Home Depot’s share count by another 7%.
All in all, Home Depot does not need a large amount of new store openings to hit an attractive earnings-per-share growth rate, which is why we forecast earnings-per-share growth of 8% annually, even if the pace of new store openings remains very modest.
Valuation, Dividend, And Total Return Outlook
Home Depot’s management expects earnings-per-share of roughly $10.03 for 2019, which means that shares are trading for roughly 19 times this year’s profits right here. This is not a low valuation, and even though shares have traded at more expensive valuations over the last couple of years, we nevertheless see some multiple compression potential towards a price to earnings multiple of 18 over the coming five years. Multiple compression could thus result in a ~1% annual headwind to the company’s total returns going forward.
This is more than made up by Home Depot’s strong dividend yield of 2.9%, though. The dividend has been raised by 32% in February, and is now roughly one and a half times as high as the broad market’s dividend yield.
When we factor in Home Depot’s forecasted earnings-per-share growth rate of 8%, forecasted total returns over the coming five years are quite attractive, at ~10% annually, made up by earnings-per-share growth (8%), dividends (2.9%), and multiple compression (~1% headwind).
Home Depot does not look like a high-risk stock at all, due to its strong competitive position, long proven track record, and healthy balance sheet. The company has delivered another outsized dividend hike earlier this year, and provides an above-average dividend yield. When we factor in the compelling total return outlook over the coming years, it is not surprising to see that the stock is among the favorite quality income picks by Mr. Wonderful Kevin O’Leary.