Buying industry-leading businesses has generally worked out well for investors over the long haul. This applies even in the home improvement space.
If you’d bought $10,000 worth of Home Depot (NYSE: HD) shares 10 years ago, you’d be sitting on a portfolio balance of $58,000 today. If we look back even further, the gains are even more impressive.
As this top retail stock sits 18% below its peak price (as of April 12), you might be eyeing Home Depot as a possible investment idea. Before buying shares, it’s important to learn what just might be its secret to success.
Understanding different customers
I’m sure you’re familiar with Home Depot’s business. It sells important tools and supplies, like lumber, appliances, and lawn and garden products, to name a few, to customers across the U.S. and in Canada and Mexico. There are a total of 2,335 locations.
But you might not be knowledgeable about Home Depot’s customer bases. The business serves DIY customers, who probably want to tackle much smaller projects around the house. This group represents about half of total sales.
The other customer cohort consists of professional contractors, electricians, plumbers, and the like. These people work on behalf of homeowners to handle bigger and more complex renovation projects.
Lowe’s, Home Depot’s smaller competitor, only generates 25% of revenue from pros. The fact that Home Depot makes more money from professionals has been key to its superior financial performance. Its return on invested capital and operating margin have both averaged a higher figure than what Lowe’s put up in the past decade.
That’s because pros visit stores more often and spend a lot more money. If a retailer had more of these kinds of customers walking through the door, the financial metrics would undoubtedly get a boost.
Consequently, it’s likely that Home Depot benefits from high switching costs. Professionals who have a long-standing relationship with the business and who rely on Home Depot as a mission-critical service provider and partner are probably very sticky and unlikely to start purchasing from a rival retailer. Home Depot caters to these customers with features like a loyalty program, volume pricing discounts, and a special customer service line.
Home Depot recently announced that it is going to acquire SRS Distribution for over $18 billion. The target has a strong presence providing roofing materials and building supplies. This will only bolster Home Depot’s standing with professionals, because it now has an even greater ability to serve their specific needs.
Short-term pessimism, long-term optimism
Although Home Depot dominates its industry, it hasn’t been immune from the ongoing macroeconomic headwinds. Higher interest rates, inflationary pressures, and lingering fears about a recession discourage people from spending on big-ticket items. This is hitting Home Depot noticeably, as revenue dipped 3% last fiscal year. Management expects the difficult times to continue.
I believe these near-term challenges will eventually subside. Home Depot has a favorable outlook if we view things with a five- or 10-year perspective. This should drive sales and earnings gains over time.
There is a housing shortage in the U.S., which incentivizes people to stay in their existing homes, focusing on upgrades and remodels. Home Depot gains thanks to this trend.
Additionally, the median age of a home in the U.S. is 40 years. Again, a high number like this spurs demand for what Home Depot sells.
The business raked in $153 billion of revenue in fiscal 2023. Even though that’s a gargantuan figure, it only gives Home Depot a 15% share of the overall industry. There is a huge growth runway to capture.
Investors who can look past near-term headwinds should consider buying the stock.
Should you invest $1,000 in Home Depot right now?
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Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.
Looking to Buy Home Depot Stock? This Might Be Its 1 Secret to Success was originally published by The Motley Fool