“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
In today’s Model Vs. Market post we’re looking at Home Depot. Home Depot has experienced an impressive run over the last 5 years, with shares up almost 400% over that time period. Home Depot is a wonderful company but it is far from trading in the clearance aisle. It is a leader in its market and has impressive profit margins relative to its peers (2015 EBITDA margin was 14.7% compared to 11.3% at Lowes). But, is it available at a fair price? It looks pretty expensive based on our discounted cash flow model.
Home Depot, Inc. is recognized as the largest home improvement retailer in the world, with average store space of 104,000 square feet and 24,000 square feet additional garden area. Its range of home improvement products, building materials and lawn and garden products are marketed under the brands Husky (tools), RIDGID and Ryobi (power tools), Defiant (door locks) Everbilt (hardware fasteners), Hampton Bay (fans and lights), Vigoro (lawn care), among others.
The firm’s customer base includes households, businesses and offices, construction and design companies, individual end-users and niche markets like DIYers, gardeners, architects, space planners and professional designers. It operates 2,269 Home Depot stores located in the US and in Canada, Guam, US Virgin Islands and Mexico. The company was incorporated in 1978 and its headquarters are located in Atlanta, Georgia.
What are shares of Home Depot worth?
The TagniFi DCF valuation model is indicating that shares of Home Depot are worth $52 which is 56% below its yesterday’s close. Here are the key assumptions used to arrive at this value:
- Revenue Growth – Over the last 5 years revenue has grown at an average rate of 5.2%. The model assumes the same growth rate for the next 4 years followed by a terminal growth rate of 2.5%.
- Profitability – Over the last 5 years the EBITDA margin has averaged 12.8%. The model assumes this same margin going forward. Increases the projected EBITDA margin to the 2015 level of 14.7% increases the valuation to $63 per share.
- Depreciation – Depreciation in 2015 was 2.1% of revenue. The model assumes this same rate of depreciation going forward.
- Income Taxes – The average effective tax rate for the last 5 years was 36.5%. The model assumes this same effective tax rate going forward.
- Capital Investment – Over the last 5 years the company has spent 1.7% of its revenue on capital investments, net of dispositions. The model assumes the same level of investment going forward.
- Working Capital – After netting out cash, short-term investments and short-term debt the company operates with positive working capital. The model assumes this will continue at the same rate as revenue grows.
- Discount Rate – The assumed cost of capital is 10%. Reducing the cost of capital to 8% increases the valuation to $75 per share.
This model was created by extrapolating the last 5 years of performance into the next 5 years of performance. Before making an investment decision you should run your own model with your own assumptions based on your own research of the company. Download a hard copy of this model to perform your own valuation and let us know what you think shares of the company are worth on Twitter @tagnifi. For the full version with links to the TagniFi database, please download the full Discounted Cash Flow Analysis model.
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