The housing market is poised for recovery.
Home Depot (HD -0.94%) is one of the best-performing stocks of all time, and it still maintains an impressive competitive advantage.
The company is a leader in the large home improvement retail industry, with a total market size of nearly $1 trillion. The company essentially has a duopoly with rival Lowe’s, allowing both companies to enjoy wide operating margins and returns on invested capital.
Home Depot has generally struggled since the height of the pandemic due to the weak housing market and the company’s business is closely tied to home sales and home improvement projects. However, as the housing market should recover, stocks should recover over the next few years. Let’s take a look at three reasons to buy the stock now.
Image source: Home Depot.
1. A housing recovery is on the way.
After the pandemic-induced housing boom ended, interest rates soared, home sales plummeted and Home Depot’s business slumped.
However, the Fed began its rate cutting cycle last month with a 50 basis point rate cut. Mortgage rates have yet to react, but with the Fed expected to cut rates another 1.5 percentage points by the end of next year, rates should fall.
Existing home sales are also about 30% lower than before the pandemic began, meaning the housing market has plenty of room to recover. Home Depot’s growth is expected to accelerate further as existing home sales recover.
Additionally, the United States has a housing shortage estimated to be in the millions, and both presidential candidates have plans to fill that gap. Home Depot is also expected to be a winner as supply and demand in the domestic housing market normalizes.
2. Home equity levels are at an all-time high
While home sales are sluggish, prices are rising. More Americans are staying in their homes for longer periods of time, which means record levels of home equity. Americans currently have more than $32 trillion in home equity, and as lending rates on home equity loans and lines of credit decline, it will become easier to leverage that equity. Today, the average borrower has about $214,000 in equity, which can help them spend on home improvement projects.
Similarly, with the stock market at an all-time high, this is another source of money Americans can invest in these projects.
Together, these developments should complement the housing recovery and fuel a potential rally in Home Depot stock.
3. Strong competitive advantage
Home Depot’s sales have been declining recently, with comparable sales dropping 3.3% in the second quarter (ending July 28). The company expects full-year sales to decline by a similar 3% to 4%.
Despite top-line weakness, Home Depot’s margins remain strong. The company plans to achieve an operating profit margin of 13.5% to 13.6% in fiscal 2024. Although down from recent highs, Home Depot is well-positioned to expand profitability during the recovery.
These numbers should reassure investors that the company can handle any challenges or headwinds it faces in the industry.
Why Home Depot is a bargain
Home Depot’s price-to-earnings ratio of 27x may not be attractive right now, but once it returns to growth, the business will have a lot of leverage. Additionally, the acquisition of SRS Distribution is starting to pay off and should help the company accelerate its entry into the professional market.
Home Depot has proven to be a winner in a broad economic moat, and the company intends to capitalize on the housing recovery and efforts to eliminate the housing shortage across the country.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool has a position in and recommends Home Depot. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.
