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The Home Depot Stock Is Estimated To Be Modestly Overvalued

·4 min read

- By GF Value

The stock of The Home Depot (NYSE:HD, 30-year Financials) is believed to be modestly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus' estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $336.72 per share and the market cap of $362 billion, The Home Depot stock gives every indication of being modestly overvalued. GF Value for The Home Depot is shown in the chart below.


The Home Depot Stock Is Estimated To Be Modestly Overvalued
The Home Depot Stock Is Estimated To Be Modestly Overvalued

Because The Home Depot is relatively overvalued, the long-term return of its stock is likely to be lower than its business growth, which averaged 12.9% over the past three years and is estimated to grow 2.25% annually over the next three to five years.

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Since investing in companies with low financial strength could result in permanent capital loss, investors must carefully review a company's financial strength before deciding whether to buy shares. Looking at the cash-to-debt ratio and interest coverage can give a good initial perspective on the company's financial strength. The Home Depot has a cash-to-debt ratio of 0.18, which ranks worse than 78% of the companies in the industry of Retail - Cyclical. Based on this, GuruFocus ranks The Home Depot's financial strength as 5 out of 10, suggesting fair balance sheet. This is the debt and cash of The Home Depot over the past years:

The Home Depot Stock Is Estimated To Be Modestly Overvalued
The Home Depot Stock Is Estimated To Be Modestly Overvalued

Investing in profitable companies carries less risk, especially in companies that have demonstrated consistent profitability over the long term. Typically, a company with high profit margins offers better performance potential than a company with low profit margins. The Home Depot has been profitable 10 years over the past 10 years. During the past 12 months, the company had revenues of $132.1 billion and earnings of $11.93 a share. Its operating margin of 13.84% better than 88% of the companies in the industry of Retail - Cyclical. Overall, GuruFocus ranks The Home Depot's profitability as strong. This is the revenue and net income of The Home Depot over the past years:

The Home Depot Stock Is Estimated To Be Modestly Overvalued
The Home Depot Stock Is Estimated To Be Modestly Overvalued

Growth is probably one of the most important factors in the valuation of a company. GuruFocus' research has found that growth is closely correlated with the long-term performance of a company's stock. If a company's business is growing, the company usually creates value for its shareholders, especially if the growth is profitable. Likewise, if a company's revenue and earnings are declining, the value of the company will decrease. The Home Depot's 3-year average revenue growth rate is better than 83% of the companies in the industry of Retail - Cyclical. The Home Depot's 3-year average EBITDA growth rate is 10.8%, which ranks in the middle range of the companies in the industry of Retail - Cyclical.

One can also evaluate a company's profitability by comparing its return on invested capital (ROIC) to its weighted average cost of capital (WACC). Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. If the return on invested capital exceeds the weighted average cost of capital, the company is likely creating value for its shareholders. During the past 12 months, The Home Depot's ROIC is 34.76 while its WACC came in at 6.93. The historical ROIC vs WACC comparison of The Home Depot is shown below:

The Home Depot Stock Is Estimated To Be Modestly Overvalued
The Home Depot Stock Is Estimated To Be Modestly Overvalued

In summary, The stock of The Home Depot (NYSE:HD, 30-year Financials) shows every sign of being modestly overvalued. The company's financial condition is fair and its profitability is strong. Its growth ranks in the middle range of the companies in the industry of Retail - Cyclical. To learn more about The Home Depot stock, you can check out its 30-year Financials here.

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This article first appeared on GuruFocus.