Financial Analysis of Home Depot

Financial Research Report: Home Depot

For stakeholders and investors, financial analysis is of great importance as it enables them to evaluate and assess a company's performance and financial health from different perspectives. One of the important aspects is financial ratios deemed important in the financial analysis of a company. Financial ratio analysis encompasses different aspects of business performance for instance profitability, efficiency, leverage, liquidity and so on. This financial research report aims to analyze the financial performance of Home Depot, Inc. which is a publicly traded company centered in the United States. Home Depot has been selected as an investment opportunity for a client and this report seeks to provide the rationale of selecting this particular company and offering as much information as possible about this company in order to explore the merits and risks in its consideration as an investment opportunity (Home Depot, 2015).

Rationale

Home Depot Inc. is the biggest home improvement retailer in the United States and the most consistent growing retailer in the history of the United States. Home Depot's main center of operations is situated in Atlanta, Georgia. The company has its retail stores in every state in America and has expanded globally into Mexico, Canada and China as well. It is a publicly traded corporation in the New York Stock Exchange (NYSE).Home Depot offers several different products for home improvements and Do-It-Yourself (DIY) products, too. The list of its products consists of plumbing, electrical, hardware, construction materials; timber, paint and floor boards just to mention a few. The consumer base of the company encompasses four different categories of consumers, which are professional consumers, Do-It-For-Me consumers and the Do-It-Yourself consumers. Home Depot is one of the consistently successful companies in the local as well as international markets, and has continued to be so owing to its mission, which is to 'know the consumer's current requirements and trends and respond to them adequately (Home Depot, 2015).

Ratio Analysis

The financial statements of a company provide a limited overview and comprehension into its level of performance. Towards gaining a much deeper insight of the performance of a company, there has to be a relatable base of evaluation and assessment. An examination of financial ratios and industry benchmarks offers the investors and the stakeholders with implements to become aware of the company's strong points and weaknesses. The following financial ratio analysis will be carried out taking into consideration the financial statements of Home Depot for the past three years 2015, 2014 and 2013.

1. Current Ratio

The current ratio is calculated as current assets divided by current liabilities. This ratio takes into consideration a period of not more than one fiscal year at a time. The ratio is a measure of the current assets with respect to the current liabilities and helps to establish and determine whether the company has sufficient liquid assets that can be used instantaneously settle immediate payments, and provide for interests, debts and other obligations (Gibson, 2009).

Current Ratio = Current Assets / Current Liabilities

2015: - 15,302 / 11,269 = 1.36

2014: - 15,279 / 10,749 = 1.42

2013: - 15,372 / 11,462 = 1.34

The current ratio of Home Depot improved from 1.34 in 2013 to 1.42 in 2014 but deteriorated to 1.36 in the year 2015. However, in as much as the current ratio declined in the last fiscal, the company still has sufficient liquidity implied by the fact that Home Depot has $1.36 of current assets for every $1 of current liabilities.

2. Quick Ratio

The quick ratio is calculated by dividing cash and short-term marketable securities plus receivables by current liabilities. This ratio is similar to the current ratio, but the difference being, in this case, it is devoid of inventories (Troy, 2008).

Quick Ratio = (Current Assets - Inventory - Advances -- Prepayments) / Current Liabilities

2013 = (15,372 -- 10, 710) / 11,462 = 0.4067

2014 = (15,279 -- 11,057) / 10,749 = 0.4029

2015 = (15,302 -- 11,079) / 11,269 = 0.3747

As depicted above, the Quick ratio of Home Depot decreased continuously over the three years from, 0.4067 in 2013 to 0.4029 in 2014 and further down to 0.3747 in the year 2015. In addition, the inventory of the company makes up a huge part of the current assets. This in turn implies that the company has small quantities of cash and cash convertibles which that can be readily used to meet short-term obligations.

3. Operating Profit Margin

The operating profit margin ratio is a profitability ratio, calculated by dividing the operating income generated by the revenue generated. In particular, the ratio makes a comparison of the amount of income the company has against what was generated in revenues. It takes into consideration the costs of production that are not linked to the direct production or manufacture of the products and services being offered. Some of these costs include administrative costs (Gibson, 2009).

The operating profit margin is calculated as:

Operating Income / Revenues

2013: 7,766 / 74,754 = 0.10388 = 10.39%

2014: 9,166 / 78,812 = 0.1163 = 11.63%

2015: 10, 469 / 83,176 = 0.1259 = 12.59%

The operating profit margin of Home Depot increased throughout the three years from 10.39% in 2013 to 11.63% in 2014 and furthermore to 12.59%. This indicates that the company's revenue and income of the company has increased significantly and the company has at the same time checked its expenses. This implies that in the year 2015, for every dollar invested by Home Depot in its operations, the company made a return of 12.59 cents.

4. Net Profit Margin

The net profit margin ratio is a profitability ratio, calculated by dividing the net income generated by the revenue generated. In particular, the ratio makes a comparison of the amount of income the company has against that generated in revenues. This ratio is indicative of the profitability levels of the company corresponding to the net income in comparison to the revenues of the firm (Troy, 2008). The operating profit margin is calculated as:

Net Income / Revenues

2013: 4,535 / 74,754 = 0.06066 = 6.07%

2014: 5,385 / 78,812 = 0.06832 = 6.83%

2015: 6,345 / 83,176 = 0.07628 = 7.6%

The net profit margin of Home Depot increased throughout the three years from 6.07% in 2013 to 6.83% in 2014 and furthermore to 7.6%. This indicates that the company's revenue and income has increased significantly and the company has also limited its expenses. This implies that in the year 2015, for every dollar invested by Home Depot in its operations, the company made a return of 7.6 cents. This indicates that the company has been not only increasing its level of profitability but also increasing their revenue levels.

5. Return on Equity

The return on equity ratio measures how well a corporation generates profit from every single dollar that it invested (financed by investors and stakeholders). In particular, the ratio gives a measure of how well the shareholders' equity is being utilized by the management of the company. The return on equity ratio is calculated by dividing the net income of the company by the equity of its shareholders.

Return on Equity = Net Income / Equity

2013: 4,535 / 17,777 = 0.2551 = 25.51%

2014: 5,385 / 12,522 = 0.4300 = 43%

2015: 6,345 / 9,322 = 0.6806 = 68.06%

The return on equity ratio of Home Depot increased throughout the three years from 25.51% in 2013 to 43% in 2014 and furthermore to 68.06%. This indicates that the management of the company is properly utilizing the shareholders' equity in generating income. The company in the year 2015 generated 68.08 cents for every dollar financed or invested by the shareholders.

6. Return on Assets

The return on assets ratio measures just how effective a company is in the utilization of its assets to generate income or proceeds. The profitability ratio is calculated by dividing the net income of the company by its total assets (Gibson, 2009).

Return on Assets = Net Income / Total Assets

2013: 4,535 / 41,084 = 0.1103 = 11.03%

2014: 5,385 / 40,518 = 0.1329 = 13.29%

2015: 6,345 / 39,946 = 0.15883 = 15.88%

The return on assets ratio of Home Depot increased throughout the three years from 11.03% in 2013 to 13.29% in 2014 and furthermore to 15.88%. This indicates that the management of the company is properly utilizing the total assets that the company has in its possession in generating income. The company in the year 2015 generated 15.88 cents for every dollar financed or employed from the total assets of the company.

7. Earnings per share

Earnings per share is also referred to as the net income per share and is a ratio that provides a measure of the amount of net income generated for every share of the company that is outstanding. Basically, it is the amount of money that every share of the company would obtain if all of the proceeds generated would be allotted to the shares of the company that are outstanding at the end of the financial year. The ratio is indicative of profitability of a company relative to its shareholders (Troy, 2008).

Earnings per share = Net Income -- Preferred Dividends / Weighted Average Common Shares Outstanding

2013 = 4,535 / 1,499 = 3.03

2014 = 5,385 / 1,425 = 3.78

2015 = 6,345 / 1,338 = 4.74

Similar to profitability ratios, the earnings per share is indicative of how well a firm is generating profits. The earnings per share of Home Depot increased in the three-year period under consideration, and this indicates that the company has been financially healthy and profitable in the immediate past. This is because, a higher earnings per share implies that the firm has generated more profits, which are to be allocated to the stakeholders. In addition, higher earnings per share ratio trend leads to an increase in the share price of the company generally. Hence, it is expected that the share price of Home Depot will continue to increase in times to come.

Risk

Home depot undertakes its business operations in markets that offer forceful competition through parameters like the prices offered, the site of the stores, the customer service provided, obtainability and quality of products as well as the assortment and array of merchandise. What is more, the company also faces forceful competition from online traders and multichannel sellers as an increasing number of consumers are drawn to making use of tablet, iPad and also smartphones to acquire products online and make a comparison of the different prices from rival companies in real time. This continually shifting competitive environment could hinder the prices of the business or even the levels of demand of the corporation's products and services. Generally, this could influence the market share of the company in addition to its overall financial performance (Annual Report, 2015).

The achievement of the corporation's business operations are partly reliant on the firm's capability to recognize and react quickly to progressing trends in the preferences, needs and anticipations of consumers, unanticipated weather conditions and also demographics. It is quite hard to have certainty in the projections of what products and services the consumers want. More so, the company faces pressure in terms of needs of the consumers coming off the recovery of the housing market. The company's overall reputation can be hampered by poor services and experiences given to consumers as this information can be shared and spread in social media and ultimately adversely impact the reputation and thereby market share of the company (Home Depot Annual Report, 2015).

Home Depot Stock Analysis

This section will analyze the stock of the company in order to ascertain the financial performance of the company. To start with, it is important to calculate the average rate of growth of Home Depot's net income, which is the dividend growth rate and can be obtained as follows:

Average Annual Growth Rate= (Growth Rate in Period 1 + Growth Rate in Period 2 + Growth Rate in Period 3 + ...Growth Rate in Period N) / Number of Periods

= ((6,345 -- 5,385) / 5,385) + ((5,385 -- 4,535) / 4,535) + ((4,535 -- 3,883) / 3,883)

= 0.5336

The stock valuation of Home Depot in this section will make use of the Dividend Growth Model. This model employs the following formula:

Stock Value = (Current Dividend * (1 + Dividend Growth)) / (Required Return - Dividend Growth)

= (2.36 * (1 + 0.5336)) / (14.10 -- 0.5336)

= 26.67

The current value of the stock for Home Depot Inc. is higher than the estimated one as it stands at $117.66.

Home Depot Future Growth Prospects

The current dynamics in the market scenario point to the fact that the future prospects of the retail industry lie in the hands of the companies or firms which have the capacity to provide a great deal of diversity in the products that they retail and also generate easy availability and ease of access of the products to the consumers. Only a few firms in this industry can be considered to have this sort of capacity. Home Depot is one of these few companies along with rival corporations such as Lowe's Companies. Nonetheless, as perceived from the financial analysis undertaken above, Home Depot has a competitive edge in comparison to the rivaling firms as the company is continuously increasing the number of its physical stores and it already has stores in all the states of the nation. This in turn increases the level of accessibility of products to the consumers (Trefis Team, 2015). In addition, the company has a diverse and wide range of products that are on offer in its stores. This assortment gives Home Depot a competitive advantage. What is more, the company's expansion of its retail stores into Mexico, Canada and also China will be of immensely beneficial for the company as it will increase the revenue generated in addition to expanding the consumer base (Soni, 2015). The corporation is also projected to grow as the prevalent operational activities level of Home Depot are not at full capacity and there is a potential capacity to improve its contemporary levels of productivity. At the same time, it is important for the business to uncover the reasons of its deteriorating market condition in China. China is one of its leading markets outside of the United States and can therefore have a worsening influence on the stream of revenue of the corporation in addition to its profit margins (Trefis Team, 2015).