We all know the reasons to own Home Depot Inc (NYSE:HD) stock. It’s the leader in a secular growth home-building and home-improvement market that has steady demand. Operations are getting a big long-term boost from smart home tech and a big short-term boost from multiple hurricanes (where there is destruction, there is rebuilding). Appliance market share is booming thanks to the sudden demise of Sears Holdings Corp (NASDAQ:SHLD). Moreover, HD stock has not only proven itself to be immune to the Amazon.com, Inc. (NASDAQ:AMZN) disease plaguing the rest of retail, but also shown a great ability to steadily grow its own e-commerce business.
Source: Mike Mozart via Flickr (Modified)
All in all, the reasons to own HD stock stretch far and wide. That is why the stock has been a steady grower for the past five years.
But growth is starting to slow. Granted, topline momentum looks as good as ever, but it looks like Home Depot is starting to max out on its ability to leverage operating expenses. That is weighing on overall earnings growth and bringing forth the realization that the days of 15%-to-20%-plus earnings growth are over.
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Does that mean HD stock is a sell? Not necessarily. There is one thing that could drive earnings materially higher, and it has nothing to do with anything Home Depot does.
Valuation and Tax Cuts
There is no hiding it. The valuation on HD stock feels stretched at these levels.
HD stock is trading at 22.7 times fiscal 2017 earnings. Meanwhile, analysts are looking at 11.1% earnings growth from 2017 to 2019. That gives HD stock a price-to-earnings/growth (PEG) ratio of just over 2.
That isn’t terribly attractive. The S&P 500 is trading around 19.4 times fiscal 2017 earnings. Earnings are expected to grow 10.6% per year from 2017 to 2019, which gives the market a PEG ratio of about 1.8.
Right now, HD stock gives investors less bang for their buck than the overall market.
Plus, the current 23.8 times trailing price-to-earnings multiple is above where the stock has traded historically over the past five years (average P/E of about 23). That premium valuation comes despite drastically lower earnings growth projections.
Over the past five years, Home Depot has turned roughly 5% annual comp growth into 20%-plus annual earnings growth. That was driven largely by tremendous Opex leverage (the Opex rate fell from 25% in 2011 to 20% last year).
But that Opex leverage is starting to slow. The Opex rate has fallen 50 basis points so far this year.