Create a Power Point presentation of 5-7 slides plus the title slide that contains the main results of the Research Project.These slides should include your recommendations, with supporting rationale,

Home Depot Group Research Project Part 2

Home Depot has continued to grow over the past 40 years into handymen and contractors go-to place to complete their work. Do-It-Yourselfers are continuing to choose Home Depot as their “go-to” home improvement store because they have fallen in love with the ability to walk into a warehouse type store to find everything they need to complete any home improvement project. Home Depot strives to provide highly-trained employees in each department to give appropriate direction on any type of project in the field they specialize in. With Home Depot’s “whatever it takes” philosophy, customers are guaranteed the best products, prices, and customer service whenever they shop at Home Depot. Their upbeat financial performance continues to challenge the obstacles that make growth difficult, including a slothful housing market, increasing household debt, rising interest rates, and higher mortgage costs (Macro, 2018). Throughout this report, we dive into Home Depot’s financial leverage ratios, bond performance, and stock performance to provide recommendations depending on Home Depot’s financial strength.

Financial Leverage Ratios

The debt to asset ratio for Home Depot has been decreasing over the last few years, which tells us that Home Depot may be becoming less dependent on loans and borrowing money to expand their company; this is a good sign that the company is heading in the right direction because without having to take out more loans to expand, will generate more profit for the company. Home Depot is displaying many signs of remaining a strong and stable company. By displaying a constant increase in their total assets, HD is displaying potential for future economic benefits that are being controlled properly.

Home Depot’s Debt to Equity has drastically increased over the last two years. “No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments are considered financially sound. For HD, the ratio of 15x suggests that interest is amply covered. High-interest coverage is seen as a responsible and safe practice, which highlights why most investors believe large-caps such as HD is a safe investment” (Andrew Edmonds, 2018). This is a good sign that the company has strong roots is continuing to produce a gain after the debt, thus continuing to grow as a company. Unsecured debt can carry a higher risk for investors; therefore, it often pays a higher interest rate than collateralized debt. They also have a strong financial department making smart moves to keep financially strengthening the company. Home Depot is constantly outdoing their competition by increasing their online sales. They are dedicated to integrating its online store with its physical store over the past few years which is keeping them ahead in the home improvement industry (Rossolillo, 2016).

The Home Depot Inc's interest coverage for the quarter, that ended in October 2018, was 15.54. The higher the ratio, the stronger the company's financial strength is (Anon, 2019). With the growing interest coverage, Home Depot is performing and will continue to perform at a higher rate; this tells us that Home Depot is developing new, efficient ways to improve its strong company. Their cash and cash equivalents present insignificant risk of changes in value because of their continuous changes in interest rates (Dybek, 2018). All three of these financial ratios will help investors measure the potential risk of buying Home Depot’s stock. If they continue moving in the direction that they are currently, then they will continue to see their stock flourish.

Bond Performance

The information for the Home Depot bonds is found on https://markets.businessinsider.com/bonds

1. Last prices of the bonds

First bond: The last price quoted was $ 123.70. For a bond of par value $ 1000, price= *1000= $1,237

Second bond: The last price quoted was $ 126.94. For a bond of par value $ 1000, price= *1000= $1,269.40

1. Annual coupon interest payments.

First bond: Coupon rate=5.8750%

Annual Coupon interest payments=5.8750%*1000= $58.75

Second bond: Coupon rate=5.9500%

Annual Coupon interest payments=5.9500%*1000= $59.50

1. Current yield of the bonds.

Current yield=

For the first bond, Current yield= = 4.75% (to 2 dp)

For the second bond, Current yield= = 4.69% (to 2 dp)

1. Analysis of the bonds.

1. The YTM listed for the first bond is 4.10% and for the second bond is 4.18%. The YTM is the yield to maturity of a bond. It is the internal rate of return that an investor earns if they buy the bonds today at the market price, assuming that the bond is held until maturity. It also assumes that all the payments made are reinvested at the same rate.

2. I would use the current yield to make the decision on which bond to invest in because it is a more accurate reflection of a bond’s profitability considering it is calculated from the purchase price. I would choose the first bond; this is because it has a higher current yield than the second bond, meaning it offers better returns than the second one.

3. The bonds are non-callable because the conditions for callable bonds are not indicated. If the bonds were callable, I would be less interested to buy them because they may expose me to reinvestment risk. The issuer may decide to call the bonds at a time, which has the most disadvantage to the buyer, therefore the desired rate of return may not be achieved. They are risky because the rate of return is not guaranteed, but they are dependent on when an issuer may call the bonds.

4. The ratios that may be of interest are the net profit margins, return on assets, and financial leverage ratios.

Stock Performance

1. a) Market Ratios for Home Depot and Lowes

b) There are many tools one can use to evaluate the current share price of a publicly-held company. Market value ratios are one of them and they consist of book value per share, dividend yield, and earnings per share. The first is book value per share (BVPS) which is “a method to calculate the per-share value of a company based on common shareholders’ equity in the company” (Hayes, 2019). The second ratio is the dividend yield and it is the “ratio of a company’s annual dividend compared to its share price” (Chen, 2019). Lastly, the earnings per share (EPS) which “is the portion of a company’s profit allocated to each share of common stock” (Kenton, Earnings Per Share - EPS, 2019). By utilizing each of these ratios it can help the investor decide if the stock they wish to purchase is either overpriced or underpriced. Home Depot has been paying consistent dividends and buying back shares (Hoang, 2019). Looking at the gross profit margin, net profit margin, and return on capital employed we can determine if the common stockholders are receiving an adequate return on their investment; by evaluating these numbers, we can see that Home Depot investors are receiving an adequate return on their investment and the growing debt pile at Home Depot is serving investors well.

The BVPS for Home Depot has decreased between 2016 to 2018. The BVPS is calculated by totaling all the company’s assets minus their outstanding liabilities. From this calculation it is clear that Home Depot is taking on larger liabilities which could hurt most smaller organizations; however, Home Depot is still the leading hardware chain in the United States. Despite the increase in liabilities, Home Depot is currently trading higher than its competitor Lowes. During the same time period, Home Depot has increased in its dividend yield, which is optimal for investors; this is because “the yield will rise when stock prices fall and will fall when stock prices rise” (Chen, 2019). By looking at the data, it can be seen that Home Depot’s stock price rose in 2017 and fell in 2018, which can implicate it is a “buying moment” for investors. From the earnings per share, it can be seen that Home Depot has increased its EPS between 2016 and 2018. This is beneficial for investors because it demonstrates that Home Depot is creating more revenue per share of the stock it sells. This ratio helps investors see the profitability of an organization and that Home Depot is creating more wealth for its investors. From the market ratios presented in the table above, it can be concluded that Home Depot investors are receiving an adequate return on their investments.

Lowes is competing well with Home Depot and looks like an advantageous investment for investors. The BVPS for Lowes has decreased, much like Home Depot, but at a higher rate; this could indicate that Lowes is taking on too much liability rather than trying to increase its assets. Those who invested in Lowes in 2016 made a wise decision because the dividend yield has decreased from 7.58% to 5.48% during the 2016-2018 period. The decrease in dividend yield shows that the stock price has increased during the same time period, which shows that investors who purchased stock in 2016 have consistently made a profit annually where Home Depot investors experienced rises and falls. Lowes experienced an increase in their EPS at the same rate as Home Depot. Much like Home Depot, it shows that Lowes is creating wealth for its investors. Based on the data in the table above, Lowes is also creating an adequate return on their investments.

c) The P/E Ratio is another tool investor can utilize to evaluate a given stocks price. When understanding the P/E Ratio investors need to understand that “a high P/E ratio can indicate that the stock is overvalued” (The Motley Fool, n.d.), and a low P/E value can indicate the stock is undervalued. The following table shows the historical P/E ratios from 2014-2018. There is no industry average for the hardware supply market or the Do It Yourself/Contractor supplies market; therefore, Lowes has been used considering it is the most comparable store to Home Depot. In 2014, both Home Depot and Lowes were very close in their P/E ratios which indicated to the investor that Home Depot was properly valued. Annually, Home Depot fell lower than Lowes except for 2017 which could indicate that in 2017, Home Depot was overvalued. In the last year, Home Depot fell well below its competition which indicates that Home Depot is properly valued or slightly undervalued. It would be reasonable to purchase Home Depot if dividend investing is what the investor is looking for. They can purchase the stock knowing that it is properly valued and can hold the stock looking for gains but can rest assured that the will continue to make dividends off the stock they hold. If the investor is looking to purchase a stock low and then turn around and sell it quickly for big gains, then Home Depot would not be the stock for them.

2. a&b)

c) Home Depot's insiders have been accumulating a large chunk of the company's shares for themselves due to the recent market weakness. Its $11.1 billion investment initiative will create more loyal PRO customers and generate more profitability. At the current price, long-term investors should follow Home Depot's insiders into the company (Hoang, 2018). The Home Depot stock, over the last year, has averaged $174.27 and has had its ups and downs as any stock does. What makes Home Depot different than others is they have made smart investments and found a way to be less dependent on loans, making it a more desirable choice for long-term investors. Also, looking at the chart, you see that the stock moves if you buy and sell a lot of stocks; this is ideal. Another aspect is with the growing population and expansion of housing needs will always be in high demand, giving Home Depot a stable industry. Many retailers have been losing businesses due to Amazon’s (AMZN) expansion. However, Home Depot has been somehow immune to Amazon’s threats (Hoang, 2018). Contractors and consumers usually need the product immediately, making it difficult for Amazon to take all the business from Home Depot, giving yet another upside to the stock.

3. a) The 10yr Treasury Note is the most appropriate measure for a risk-free rate because it is backed by the United States government. The strength and stability of the United States Treasury guarantee the rate for a decade and therefor is the most appropriate to use as a measure of risk-free rates.

b) From 1926 to 2017 and annual rate of return for the S&P 500 has averaged a 10% return. Despite the ups and downs of the market and through catastrophic incidents such as the Great Depression and many other depressions along with Recessions; the United States stock market has maintained its 10% return average.

c&d)

2.

3. The Gordon model is the only model which indicates that the current stock price of $186.01 is overvalued for Home Depot. The CAPM indicates that Home Depot is undervalued. When utilizing CAPM “if the discounted value of future cash flows is equal to (price of the stock) than the CAPM formula indicates the stock is fairly priced” (Kenton, Capital Asset Pricing Model-CAPM, 2019). The growth rate of Home Depot is currently at 168.66%, which indicates that Home Depot is being more than adequately managed and will increase in capital for the investor over time. Home Depot is currently at 298.25% Return on Equity, which indicates that Home Depot adequately utilizing its revenues and investing in the proper departments to ensure its growth.

4. Finally, the only model which indicates that Home Depot is overvalued is the Gordon Growth Model which indicates Home Depot should be priced at $8.29. The Gordon Growth Model is a great model for helping investors decide if a stock is over or undervalued but it does have its limitations. The Gordon Growth Model because it does not take market considerations into account, nor does it account if hardships/windfalls for business. Two of the three models indicated that Home Depot is fairly priced and would be a good investment for any investor. Looking at stock prices alone indicate that home depot has gained in capital between 2014 when is sold for $79.13 and 2018 when it sold for 178.24 which is in an increase in capital of $99.11.

Recommendation for the Client

The net profit margin for Home Depot has been increasing over the years (Morningstar.com, 2019). This means that the company is getting better returns from its investments. Therefore, it would be better for an investor to invest in the bonds of the company because they indicate that it is performing better financially. An investor should be concerned about the risk of investment. Although a high financial leverage ratio may indicate that a company is expanding through borrowing, it may also pose a significant risk of default to the investor because of excessive debt. In Home Depot’s case, the increasing financial leverage ratio may mean that the company is increasing their borrowing; this may pose a concern to a risk-averse investor because of the potential for default on its coupon interest payments. However, a close look at other ratios for Home Depot provides a good picture for the investor. The most important ratios have been improving over the years, signaling a better outlook for the company in the future. Over the years, since 2009, the return on assets, return on capital employed, return on equity, and return on invested capital have all been increasing (Morningstar, 2019). This may indicate that the company is putting to greater use its debt and therefore generating more returns for the shareholders. It indicates a robust financial strength for the company and the investor may be interested in investing in the company’s bonds and stocks. Therefore, the investor should invest in the bonds and stocks of the company because all the crucial financial performance indicators such as ratios have been increasing over the years. If the company maintains the same trend, it means it will continue registering a good performance.

Recommendation for Home Depot Management

Financial leverage ratios include the debt/equity ratio; this measures the ratio of a company’s debt relative to its equity. In this case, the average financial leverage ratio for Home Depot has been increasing over the years (Morningstar.com, 2019). This means that the level of debt has been rising relative to the equity. Management should stay up-to-date with their financial leverage because it informs them of the amount of debt they can use to buy more assets. They should be cautious of the amount of financial leverage they have because this could be a risk of failure and will result in making it more difficult to repay debt. Home Depot management has announced a new dividend policy and its strong guidance for the current year, which ultimately sent shares higher (Hoang, 2019). Home Depot’s credit rating is increasing due to its improving performance over the past few years; this lets management know that Home Depot has a strong capability to meet its financial commitments. Management can see, by looking at Home Depot’s market position, that their company has achieved higher profitability than its competitors. Management should continue utilizing online sources to expand their customer base and internet sales to help improve their overall net sales.

Reflection

During this assignment, we have learned that Home Depot’s financial leverage has been steadily increasing, allowing management to buy more assets. Using the current yield, to make the decision on which bond to invest in is ideal because it is a more accurate reflection of a bond’s profitability considering it is calculated from the purchase price. Market value ratios are an excellent tool to use to evaluate the current share price of a publicly-held company; it consists of book value per share, dividend yield, and earnings per share. Utilizing each of these ratios will allow us to decide if the stock we wish to purchase is either overpriced or underpriced. Different financial models will give you different opinions about whether or not a stock is overvalued, undervalued, or properly valued; therefore, it is crucial to analyze all ratios and financial leverage to determine whether or not the company’s financial health is strong and reliable.

References

Andrew Edmonds (June 24, 2018) Simply Wall street Does The Home Depot Inc’s (NYSE:HD) Debt Level Pose A Problem? https://simplywall.st/stocks/us/retail/nyse-hd/home-depot/news/does-the-home-depot-incs-nysehd-debt-level-pose-a-problem/

Anon, (2019). [online] Available at: https://www.gurufocus.com/term/interest_coverage/HD/Interest-Coverage/The-Home-Depot-Inc [Accessed 21 Feb. 2019].

BusinessInsider.com (2019). Home Depot Bonds. Retrieved from https://markets.businessinsider.com/bonds

Chen, J. (2019, February 25). Dividend Yield. Retrieved from Investopedia: https://www.investopedia.com/terms/d/dividendyield.asp

Dybek, M. (2018, March 23). Home Depot Inc. (HD) | Assets. Retrieved February 24, 2019, from https://www.stock-analysis-on.net/NYSE/Company/Home-Depot-Inc/Financial-Statement/Assets

Hayes, A. (2019, February 16). Book Value Per Common Share - BVPS Definition. Retrieved from Investopedia: https://www.investopedia.com/terms/b/bookvaluepercommon.asp

Hoang, A. (2019). Investors Should Follow Home Depot's Insiders Into The Company. [online] Seeking Alpha. Available at: https://seekingalpha.com/article/4229383-investors-follow-home-depots-insiders-company [Accessed 21 Feb. 2019]

Kenton, W. (2019, February 18). Earnings Per Share - EPS. Retrieved from Investopedia: https://www.investopedia.com/terms/e/eps.asp

Macro, I. B. (2018, November 29). Home Depot Prices US$3.5bn Bond While Weathering Sluggish Housing Market. Retrieved February 28, 2019, from https://seekingalpha.com/article/4225465-home-depot-prices-us-3_5bn-bond-weathering-sluggish-housing-market

Morningstar.com (2019). The Home Depot Inc. Retrieved from http://financials.morningstar.com/ratios/r.html?t=HD&region=usa&culture=en-US

Rossolillo, N. (2016, April 01). What Home Depot Is Doing Right That the Competition Isn't. Retrieved February 24, 2019, from https://www.fool.com/investing/general/2016/04/01/what-home-depot-is-doing-right-that-the-competitio.aspx

The Motley Fool. (n.d.). What Is the Relationship Between P/E Ratio and Stock Price? Retrieved from The Motley Fool: https://www.fool.com/knowledge-center/the-relationship-between-pe-ratio-and-stock-price.aspx