Introduction
Home Depot Incorporated is an American retailer of products and services related to construction, home design and home improvement. The products offered by the company include hardware supplies, paint, plumbing materials, gardening tools, plants and home appliances. The company is the largest retailer of home improvement services in the United States operating over 2,248 retail stores within the country. Other geographic locations in which the company operates include neighbouring countries such as Canada, Mexico and China. The company which was founded in Marietta, Georgia in 1978 currently operates in Atlanta, Georgia. As at January 2011 the total number of employees working for the various retail stores of the company worldwide amounted to 321,000. The current Chief Executive Officer and Chairman of Home Depot is Frank Blake who acted as the vice chairman of the company before taking over from Robert Nardelli (Gogoi par.1)
The principal or main products sold by Home Depot Inc. include BEHR Paint, Chem-Dry which is a product used for carpet cleaning and also upholstery cleaning; water heaters, furniture for both the indoors and outdoors, gardening supplies, carpentry tools such as those designed by Ryobi and also cabinets from Thomasville. The company’s net income for the year ended 2011 amounted to $3.338 billion dollars while the operating income for the same financial year amounted to $5.839 billion dollars. Home Depot is listed in the New York Stock Exchange operating under the ticker symbol of HD. The closing market price of the company’s stock as at May 7th 2011 was $34.29 dollars while the dividend per share was $0.25 (Morning Star par.1)
The independent accountants of the company for the year 2011 were KPMG LLP based in Atlanta, Georgia. KPMG is responsible for independently auditing the company’s financial statements after the end of the company’s financial year while the main responsibility of reviewing the company’s financial performance is done by the audit committee. The audit committee provides auditing and financial information to the company’s Board of Directors which is then used to implement accounting policies designed to improve the performance of the company (Home Depot par. 1-3)
Industry Situation and Company Plans
The industry in which the company operates is referred to as the home improvement industry and the main competitor of Home Depot is Lowes retailers who also sell home improvement products similar to those of Home Depot. Lowes also has a similar retail and warehouse set up like that of Home Depot as well as specialty interior stores that provide home appliance products and services. Other companies that operate within the home improvement industry in the United States and pose a minimal threat to Home Depot include Sears, Frank’s Nursery and Ace Hardware stores (Home Depot.com par.1)
Frank’s Nursery for example has focused its business on providing gardening supplies and planting materials while Sears has concentrated on providing home appliance products such as cookers, Sears ovens, microwaves, washing machines and refrigerators. Sears therefore competes with Home Depot in providing home appliances while Frank’s Nursery is the main competitor of Sears when it comes to gardening supplies (Home Depot.com par.1). The table below represents a SWOT analysis of Home Depot
The management’s future plans for the company based on an annual report for the 30th of January 2011 are that Home Depot will be able to increase its GDP growth and also improve customer growth so that it can increase its business operations. In the previous year, the company experienced negative sales especially in the Canadian retail stores which were mostly attributed to the home renovation tax credit of 2009. The company’s managers expected the pressure created by this tax credit to ease off during the later stages of the year enabling business in Canada to resume as normal (Home Depot Report 3).
A letter written to the stakeholders of the company by Francis Blake revealed that the company would continue to pursue the merchandising systems it had established in 2010 so as to improve data warehouse management and also improve the tools used for forecasting within the company. The company also has a future plan of increasing capital allocation by returning excess cash held by the company to its shareholders in the form of share repurchases and dividends. To do this, Home Depot’s management has come up with a dividend payout of approximately 40 percent of the company’s earnings (Home Depot Report 4).
Financial Statements
The income statement for the company for 2011 showed that the company made a net income of $3,338 million compared to that of 2010 and 2009 which was $2,661 and $2,260 million dollars respectively. The gross profit for the company was $23,304 million dollars which was higher compared to that of 2010 which was $22,412 million dollars. The net income for 2011 was however lower compared to that of 2009 which saw the company attaining a gross profit to $23,990. The operating income for Home Depot amounted to $5,839 million dollars which was a relative increase compared to that of previous years 2009 and 2010 which amounted to $4,359 and $4,803 million dollars respectively. The general trend from this information is that the gross profit, operating income and net income of the company has continued to increase over a period of two years indicating that Home Depot is a profitable company (EBIT par.2).
An examination of the company’s balance sheets for the first quarter of 2011 reveals that the total assets of the company amount to $40,125 million dollars while the total liabilities for the company amounted to $21,235 million dollars compared to the previous year’s total liability amount of $21,484 million dollars. The total asset value for Home Depot for 2010 and 2009 amounted to $40,877 and $41,164 respectively while the total liability for the same period amounted to $21,484 and $23,387 million dollars. The total stockholder’s equity for Home Depot in 2011 amounted to $18,889 million dollars which was lower than that of the previous year estimated to be $19,393 million dollars. The stockholders’ equity was however higher than that of 2009 where the company incurred $17,777 (EBIT par.2)
To demonstrate that Assets = Liabilities + Stockholders Equity for 2011, the total liabilities of Home Depot $21,236 will be added to total stockholder’s equity of $18,889 to give a figure of $40,125 for the company’s 2011 total assets. The total asset amount for 2010 will be an addition of Home Depots 2010 total liabilities which amounted to $21,484 and the stockholder’s equity of the company for the same year which amounted to $19,393 dollars. This means that the total assets for Home Depot for the year 2010 will amount to $40,877 million dollars and those for 2009 will be $41,164 million dollars (EBIT par. 2).
The cash flows from operations within the company for the first quarter of 2011 have been relatively lower compared to those of the past two years which saw the company operating at a net cash flow of $5,125 for 2010 and $5,528 for 2009. The company’s main investing activity has been the sale of property and equipment which has been able to provide considerable returns for the company for the past five years of the company’s business operations. For example in the past two years the company has been able to gain net proceeds for property and equipment investments of $178 and $147 million dollars (EBIT par.2).
The company’s most important source of financing is the sale of common stock owned by the company which has enabled Home Depot to gain considerable returns from these proceeds. For example in 2006, the company was able to gain $414 million dollars from the sale of the company’s common stock while in the following year 2007 the company was able to gain $381 million dollars from the sale of its common stock. Therefore the proceeds from the sale of company common stock were the main financing activities of Home Depot (EBIT par.2). An examination of the company’s cash flows for the past two years reveals that the cash flow for 2010 was higher than that of 2009 and 2011 with the company recording a net cash flow of $1,421 million dollars compared to $519 million dollars for 2009 and $545 million dollars for 2011. The trend is therefore unpredictable as the cash flows keep increasing or decreasing with the various investments and financing activities initiated by the company (EBIT par. 2).
Accounting Policies
The significant accounting policies based on the annual report released for the first quarter of the company included merchandise inventories, self-insurance, goodwill, revenues, impairment of long-lived assets and vendor allowances. The merchandise inventories of Home Depot represent 20 percent of the company’s merchandise balance which is used to reflect the market conditions in which Home Depot operates in. To determine the merchandise inventory of the company, a cost method is used at the end of each quarter to calculate the inventory value (Home Depot Report 26).
Revenues for Home Depot are calculated by evaluating the net returns of the company and also the tax after sales once goods have been sold to consumers. Based on Home Depot’s view, sales returns are deemed to be an accurate reflection of the sales returns that the company expects to gain in the future. Self-insurance is also another accounting policy that is critical to Home Depot because the company has to insure itself against certain losses that might arise during business operations. Vendor allowances are amounts of money paid out to the company’s vendors so that they can promote the company’s products to consumers. Vendor allowances consist of volume rebates that are earned by vendors when they attain certain purchase levels for the company (Home Depot Report 27).
Impairment of long-lived assets is another important accounting policy utilised by Home Depot where assets that have been utilised for a long duration are evaluated to determine their potential for impairment. The main criterion that is used for impairment includes a history of losses, management’s decision to impair a certain asset or changes that might be brought about when an asset is unrecoverable. Goodwill for Home Depot represents the excess of a product’s purchase price over the fair value of net assets where goodwill is not amortized but assessed to determine whether it can be recoverable. Goodwill for the company is usually assessed in the third quarter of the company’s fiscal year so as to determine the fair value of every unit (Home Depot Report 28).
Ratio Analysis
The tests of profitability for the company will involve determining returns of equity, returns of assets, financial leverage, earnings per share, quality of income, profit margins and average fixed asset turnover ratio. Return on equity for home Depot will be: ROE= Net income/ Shareholders equity where the net income for 2011 is $3,338 and the shareholder’s equity is $18,889.
ROE will be 3,338/18,889 = 17.67
Return on assets (ROA) is a profitability ratio that is calculated by the net income of a company divided by the company’s total assets. Return on assets= net income/ total assets, 3,338/40,125= 8.32. Earnings per share is the amount of earnings a company gains per each outstanding share of a company’s common stock. The formula for this ratio is Earnings per share= Net income/ weighted average common shares. The net income earned by Home Depot for the first quarter of 2011 is $3,338 million dollars while the weighted average common shares for the same period amounted to $1,648 million dollars. Earnings per share will be; 3,338/1,648= 2.01.
Average fixed asset turnover ratio is used to show the relationship that exists between annual net sales and the net amount of fixed assets. The net sales for Home Depot for the first quarter of 2011 averaged $67,997 while the net amount for fixed assets for the same quarter amounted to $25,060. The average fixed asset turnover for Home Depot is: Net Sales/ Net fixed assets, 67,997/25,060= 2.7. The profit margins for Home Depot include the gross profit margin, operating profit and net profit. The gross profit margin indicates the percentage revenue that can be availed to cover the operating expenses of a company. Gross profit margin for Home Depot will be gross profit ($23,304) divided by net sales ($67,997) made by the company for the first quarter of 2011: 23,304/67997= 34.27.
The operating profit margin is calculated by dividing the operating income of a company by net sales. The operating income for Home Depot was $5,839 while net sales made by the company totalled $67,997. The operating profit margin will be 5,839/67,997= 8.59. Net profit margin is net earnings/net sales therefore the net profit margin for Home Depot will be 3,338/67,997=4.91. Financial leverage is used to test the profitability of a company by calculating the percentage change in net income for a one percent change in the company’s net income.
The formula for calculating financial leverage for Home Depot will be financial leverage= operating income/net income, 5,829/3,338= 1.74. Quality of income ratios evaluates the performance of a business to determine whether it is profitable or not. The ratio shows the percentage of earnings that the company has been able to actualize into cash. The quality of income ratio is calculated by dividing the cash flows from operating activities by the net income where the cash flows from operating activities for Home Depot will be $5,839 and net income is $3,338. Quality of income will therefore be 4,585/3338= 1.3
The cash ratio, which tests the liquidity of the company, evaluates a company’s total cash, cash equivalents and current liabilities by determining the ratio between these two. The cash ratio for Home Depot will be the company’s cash and cash equivalents of $545,000 divided by the current liabilities of the company which amount to $10,122,000 (545/10122=0.053). Current ratio is also another measure that is used to determine the liquidity of a company and it is calculated by dividing the current assets of a company with the current liabilities. Current ratio for Home Depot will be current assets/current liabilities, 13479/10122= 1.33. The quick ratio measures the ability of a company to use its quick assets so that it can impair its current liabilities. The formula for the ratio is Quick Ratio=Total Assets/Total Liabilities, where the quick ratio for Home Depot will be 40125/21236=1.88
The receivables turnover ratio measures the liquidity of a company by evaluating the number of times receivables are collected from the company within certain duration of time. The formula for receivables turnover is: net receivable sales/average net receivables where the receivables turnover for Home Depot will be net receivables of $1,085 for the first quarter of 2011 and the average net receivables of $964. The receivables turnover ratio for Home Depot will therefore be 1085/964= 1.12. Inventory turnover ratio measures the number of times inventory is sold or used by a company in a certain period during the year. The formula for calculating this ratio is cost of goods sold/average inventory where the inventory turnover ratio for Home Depot will be cost of sales $9,856 and average inventory of $10,625. Inventory turnover ratio will be 9856/10625= 0.93
Times interest earned is used to measure a company’s ability to meet its long term debt payments. The formula for times interest earned is:
EBIT (earnings before interest and tax)
Interest charges
Times interest earned for Home Depot will be the earnings for the company before interest of tax of $1,037,000 and interest charges of 4000 leading to a times interest earned of 1037/4= 259. Cash coverage measures the ability of a company to generate interest as well as principal payments. The formula for cash coverage is
Net income + depreciation and amortization where the cash coverage ratio for Home Depot will be 3338+1718= 5056. The debt-to-equity ratio calculates how much money a company can be able to borrow for a long period of time. The formula for the debt-to-equity ratio is: total liabilities/shareholders equity where the debt-to-equity ratio for Home Depot will be 21236/18889= 1.12. The price-earnings ratio is used to measure the current share price of a company where the formula for price-earnings is: Market value per share
Earnings per share (EPS)
The price-earnings ratio for Home Depot will be a market value per share of $11.39 divided by earnings per share of 2.01 which will give a price-earnings ratio of 5.67(11.39/2.01). The dividend yield ratio provides a company with an opportunity to pay out dividends to its shareholders based on the share price of the company’s common stock. The dividend yield ratio is calculated by dividing the annual dividends per share by the price per share of a company. The current annual dividend per share for Home Depot is 0.96 while the price per share is $11.39. The dividend yield ratio will therefore be 0.96/11.39=0.084
Conclusion
Based on the ratio analysis of Home Depot, buying the common stock of Home Depot would be a good investment idea because the ratios demonstrate the profitability and liquidity of the company within its industry. An evaluation of the industry average in the New York Stock Exchange reveals that the company’s market share price was operating at a price-earnings ratio of 16.33 against the industry’s ratio of 14.87 and the industry sector’s ratio of 20.96. The earnings per share for the company were 24.73 which were higher than that of the industry and its sector. The return on investment for the company was valued at 11.23 against the industry’s ROI of 6.00 and the sector’s return on investment of 2.26. The return on equity for Home Depot based on industry averages was 18.23 compared to that of the industry estimated at 8.42 and that of the sector estimated at 3.76.
The above industry averages are a strong indication that the company has a strong market share price which means that investors and stockholders would gain considerable returns from purchasing Home Depot’s common stock. Analysis of the industry average has also revealed that the company’s share price has experienced a small price change which has had a minimal impact on common stock. The general consensus from most industry analysts is that more stockholders should buy the company’s stock because of the strong share price and also the profitability of the company. The analysis has also revealed that the company has strong market testability and it is able to liquidate its current assets and liabilities in an efficient manner.
Based on the ratio analysis as well as a review of current industry averages on the performance of the company in the New York Exchange Stock market, Home Depot would be a good investment option for potential shareholders because of the considerable returns shareholders would gain from their investments. Shareholders and/or potential investors should therefore invest in Home Depot because they will gain considerable returns from purchasing the company’s common stock.
Works Cited
EBIT. Home Depot Inc.(HD) : financial statements. n.d. Web.
Gogoi, Pallavi. Home Depot’s surprising choice for CEO. 2007. Web.
Home Depot. Audit committee charter. 2011. Web.
Home Depot.com. SWOT analysis. nd. Web.
Home Depot Report. Annual report 2010. Web.
Morning Star. Home Depot Inc. 2011. Web.