HD & LOW Stock: Buy These Cash Flow Machines On The Pullback

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Logos for both companies

LOGOS for both companies

Sources: Home Depot & Lowe’s

Home Depot & Lowe’s Outperformed the S&P500 from 1978 through 1982 and During a Period of High & Double-Digit Inflation

Inflation and the fear of lingering inflation is generating volatility in capital markets. During 1979, 1980 and 1981, the U.S. experienced double-digit inflation, as measured by the consumer price index [CPI], and both Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW) outperformed the S&P500 during this period [see below chart, developed using my Fidelity account – January 2, 1978 through December 31, 1982]:

Fidelity

Fidelilty

With the new stay-at-home and post-Covid paradigm shift, there is every reason to believe that both HD and LOW will do as well as the U.S. enters a new period of high inflation.

A Paradigm Shift from Uncompensated Commuting to the Stay-at-Home Home Office

Covid shutdowns have forced school closings and work interruptions over an extended period of time. This has encouraged many to focus on home improvement projects, since they have had to convert a room to a home office and have had to reconsider health risks associated with face-to-face socialization. While it is reasonable to assume that a significant portion of the increased cash flows from operations enjoyed by Home Depot and Lowe’s have benefitted from these stay-at-home and reduced socialization measures, it is not reasonable to believe that the alleviation of Covid-related pressures or higher inflation will result in a reduction of operating cash flows. The above graphic illustrates this point, where it includes 1979, 1980 and 1981, represented 3 continuous years with double-digit inflation.

Charting the More Recent Increases in HD and LOW Price-per-Share

Below is the 2-year chart for both HD and LOW, created using my Fidelity account on Saturday, January 15, 2022. The chart covers the 24-month or 2 calendar year period from January 2, 2020, through December 31, 2021 [the Covid period]. Note that Lowe’s is a little bit more volatile, when compared to Home Depot [the Beta measure, using my TDAmeritrade account, was 1.0 for Home Depot and 1.3 for Lowe’s]:

Fidelity chart on HD

Fidelity

Below is a slightly revised 2-year chart for both HD and LOW, created using my Fidelity account on Saturday, January 15, 2022. I provide this chart for comparison to the above, as it includes a very recent pullback [see the orange arrows and box in the below graphic] in the price-per-share [PPS] for both stocks:

Fidelity

Fidelity

There is no reason to believe that the work-from-home trend will be completely reversed. In fact, there is quite a trend toward work-from-home preferences reported, frequently, on both business news and popular press outlets.

Operating Cash Flows Doubled in 4 Years for Both Home Depot and Lowe’s

Both HD and LOW enjoyed a doubling of positive cash flows from operations over a 4-year period. This is illustrated in the below data, captured from my TDAmeritrade account on January 15, 2022, for HD:

TDAmeritrade

TDAmeritrade

Note that cash flows from operations have increased from $9.7 million to $18.8 million in 4 years [see above, where measures are in millions of dollars].

The below data was captured from my TDAmeritrade account on January 15, 2022, for LOW:

TDAmeritrade

TDAmeritrade

Note that cash flows from operations have increased from $5.6 million to $11.0 million in 4 years [see above, where measures are in millions of dollars].

Will Inflation and Increasing Mortgage Rates Provide a Headwind for Home Depot and Lowe’s?

I wanted to get some idea of just the impact of rising interest rates and mortgage rates might impact Home Depot and Lowe’s. Perhaps higher inflation and higher mortgage rates will reduce the demand for home ownership and home improvement tools and materials?

I examined some monthly measures from January 1985 through December 2021. I also isolated that methodology by separately examining the 2-year or 24-month period from January 2020 through December 2021.

This represents only a very basic examination of the post-1979, 1980, and 1981 period, where we had 3 consecutive years of double-digit inflation, as measured by the consumer price index. 1985 forward was selected to exclude this high inflation period.

Similarly, the 2-year or 24-month period from January 2020 through December 2021 is what I might refer to as “the Covid period,” where I am interested in getting some descriptive statistics and looking at a graphic to see just what type of impact this period had on the PPS for both Home Depot and Lowe’s.

Below are some graphics for Home Depot for the January 1985 through December 2021 time period:

30 year mortgage rates & HD stock price

My Excel file

I used data from Yahoo! Finance for the adjusted closing stock PPS for Home Depot and this site for the 30 year mortgage rates. 30-year mortgage rates remain historically low, so I am not sure that an additional 1% or 2% increase in mortgage rates for 2022 would have any significant, negative impact on home purchases and/or improvement projects requiring the purchase of tools or building materials.

The correlation is inverse, intuitively appealing, and with a single independent variable, higher (lower) mortgage rates explain about 43.5% of the increase in the Home Depot stock PPS. This correlation may or may not be causal – this is for you to decide – however, I find it intuitively appealing to believe that higher mortgage interest rates make it less likely for the average citizen to qualify for a 30-year mortgage and home ownership, while the “anticipation” of higher mortgage rates might encourage renters to buy.

Below are some graphics for Home Depot for the January 2020 through December 2021 time period:

My Excel file

My Excel file

Again, I used data from Yahoo! Finance for the adjusted closing stock PPS for Home Depot and this site for the 30 year mortgage rates. Also, again, 30-year mortgage rates remain historically low, so I am not sure that an additional 1% or 2% increase in mortgage rates for 2022 would have any significant, negative impact on home improvement tools or materials.

The correlation is, again, inverse, remains intuitively appealing, and with a single independent variable, higher (lower) mortgage rates explain only about 9.8% of the increase in the Home Depot stock PPS. Again, this correlation may or may not be causal.

The decrease in the correlation and explanatory power for the 1985 through 2021 period and at 43.5% to 9.8% for what I choose to refer to as “the Covid period” [2020 & 2021] may or may not be causally linked, but, having lived through the double-digit inflationary period of 1979 through 1981 and given the concerns that Americans appear to have with respect to current and future, near-term levels of inflation, I chose to focus on these measures.

Year-to-Date Price-per-Share Changes for Home Depot and Lowe’s and Relative to the S&P500

The below chart provides a 2022 year-to-date [YTD] graphic and comparison for the S&P500, HD and LOW:

Fidelity

Fidelity

HD and LOW are underperforming, YTD, relative to the S&P500. In addition to any stock PPS appreciation that might be expected, HD provides an annual dividend of $6.60 per share for a yield of 1.85% [source is TDAmeritrade] and LOW provides an annual dividend of $3.20 per share for a yield of 1.4% [source is TDAmeritrade]. Both stocks have a ranking of 10 out of 10 and a “strong buy” rating on TDAmeritrade.

Limitations

Parts of this article uses correlation, and it was not my intention to design an exhaustive, predictive model. I do enjoy running some descriptive statistics on some of my stock picks. It reduces the subjective level of the decision-making process. There remain many subjective variables that I have not addressed.

For example, I cannot quantify the offset for higher home mortgage interest rates against the reduction of costs associated with stay-at-home employment or the reduction or elimination of unprofitable commuting and related costs. Commuting time is not compensated. Additional automobile, parking and related expenses are reduced and/or eliminated, as is the uncompensated time consumed for an employee to dress for “the office.” In my case, I would prefer to buy a larger, more expensive home to provide for the home office and avoid the costs associated with “going to the office” every weekday, as this article suggests.

Summary

I like both Home Depot and Lowe’s as long-term buy-and-hold stocks. Covid has “forced” many to remain at home, and resulted in a paradigm shift, as some employers are having to pay bonuses, just to get employees to return to the office or attract new employees. More time spent at home is likely to warrant additional home improvements, while rising inflation rates and nominal home mortgage interest rate increases may encourage some to avoid rents and purchase a home.

An examination of the last high/double-digit inflation period – 1979, 1980 and 1981 – suggests that higher mortgage rates and higher inflation will not adversely impact home improvement trends and I believe that Home Depot and Lowe’s and their stock prices will continue to do relatively well, as Americans adapt to higher inflation rates during the post-Covid years.

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