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The Power of a World Class Business Model: Overcoming Idiocy



March 26, 2014 – Comments (2) | RELATED TICKERS: HD

I've been doing quite a bit of historic financial data collection over the past several months.  I've collected complete financial statements on about 50 companies now, each with about 20 years of data.

Today I happened to collect data on the Home Depot.  Many aspects of what they've done over the past 20 years have been very impressive.  However, actions the company took in 2006 and 2007, in hindsight, looked incredibly foolish (lowercase f for all you Motley Fool homers).

Just as a sort of disclosure, I haven't [nor do I intend to] read any 10Ks or shareholder letters for HD.  This is just analysis based on the historic financial data I've collected.

At the close of 2005, Home Depot appeared to be humming along quite nicely.  Revenue was up 10% from the prior year, and net income was up even more.  The company repurchased $2.5B in stock and paid out $850MM in dividends.  Returns on Equity and Assets were clocking in at multi-year highs.

Debt-to-book equity was at a very conservative 15%. 

And then, management got greedy.  Very greedy.

With whispers in their ears that housing was going to continue its perpetual growth (I don’t know that, I'm just guessing), HD management decided to open the debt flood gates (this part I know, for sure). 

In an effort to repurchase over $6.3B in stock in 2006 and increase their annual dividend by roughly 50% in a single year, Home Depot added over $7B in debt.  In just one year, their debt to equity ratio jumped from 15% to 47%.  The average purchase price of shares repurchased was over $70/share.  HD ended the year around $40/share.

If at first you don't succeed...

Not to be outdone by 2006's actions, HD management decided to try it again in 2007.   Tacking on another $2B in debt, HD repurchased $10B in shares!  Talk about trying to time the market!  Debt-to-equity was now at a record high 76% - up from 15% just two years prior. Even though HD finished the year under $30/share, the average repurchase price per share was $50/share.

Then we all know what happened.  The housing boom didn't continue forever and profits got hammered.  Home Depot was in no shape to handle a financial crisis, having just added nearly $10B in debt over a 2 year span.  During nearly all of 2008 and 2009, shares traded between $20 and $30/share.

Home Depot spend over $16B repurchasing shares above $50/share from 2006-2007 and didn’t repurchase any shares from 2008-2009.  Rather, management reduced their debt level by $4B.

And yet, where does Home Depot stand today?  Shares are trading near all-time highs, well above levels from 2006 and 2007 and up roughly 250% from where they stood during the lows in 2009.  Earnings per share are at all-time highs.  They have recovered quite nicely.

I think this speaks testaments to how even in the face of what appears to be horrible financial management decisions, strong businesses bounce back.  Top-tier business models persevere.  I’m fully aware of the existence of rare exceptions (GM, Lehman, WaMu), but in those cases we’re talking about only a handful of major companies (out of 500 or so) that didn’t make it, in a time period that could very well be once-in-a-lifetime.

So, we all now know that I think HD is a world class company.  So would I buy HD right now?  Well since you asked…

With whispers in their ears that financing is at all-time low interest rates (I don’t know that, I'm just guessing), HD management decided to open the debt flood gates again in 2013.

In an effort to repurchase over $8B in stock in a single year (talk about trying to time the market), Home Depot added roughly $4B in debt.  In just one year, their debt-to-equity ratio jumped from 61% to an astounding 118%.  The average purchase price of shares repurchased was over $100/share.  HD ended the year around $80/share.

To be continued…I'll pass on shares.

2 Comments – Post Your Own

#1) On March 27, 2014 at 3:45 PM, EnigmaDude (51.80) wrote:

Interesting analysis. As a homeowner, I love my local HD store but I'm not convinced that they have a very intelligent management team and your analysis confirms it.

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#2) On March 28, 2014 at 8:19 AM, lemoneater (58.88) wrote:

Robert Nardelli was CEO at Home Depot from 2000 to 2007. He practically ran it down into the ground. Then he moved on to Chrysler which declared Chapter 11 bankruptcy in 2009. I assume that he does not learn from his mistakes. Why should he? It is not as if he is unemployable or indigent from his wrong choices.

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