Home Depot (NYSE:HD) will report its earnings for the year ending on Feb. 25. This year Home Depot stock will likely be winner, just like it was in 2019.
Last year, HD stock rose 21.3% and its total return was 23.81%. This was slightly better than the Dow Jones Industrial Average, which produced a 23.76% total return. Home Depot is a component of the Dow index.
Home Depot has projected that its 2019 sales will be 1.8% higher than 2018. But its free cash flow (FCF) is likely to do much better. This helps move Home Depot stock higher during the year.
Powerful Cash Flow Powers Home Depot Stock
For example, as of its fiscal third-quarter ending Nov. 3, 2019, Home Depot produced free cash flow over the last 12 months (LTM) of $11.04 billion. This was 9.75% higher than the LTM FCF of a year ago.
More importantly, as you can see in the chart, Home Depot’s LTM FCF has been very powerful and steady. This leads to an estimate Home Depot’s full-year 2019 FCF will also be roughly close to that of Q3 on an LTM basis.
Moreover, Home Depot has a very stable FCF margin. In the past year, FCF on an LTM basis has ranged from 9.8% of sales to 10% of sales each quarter.
History of Paying Higher Dividends Each Year
Home Depot has a strong record of paying higher dividends each year. This is powered by the growth in its FCF.
For example, you can see in the chart that Home Depot’s cash flow more than covers its dividend payments each quarter.
The blue column amounts, which represent the total dollars generated in FCF, are larger than the dividend payment amounts in yellow.
Moreover, Home Depot had followed a very robust practice of buying back its shares. As a result, its dividends per share have risen very fast over the past 10 years.
In fact, since 2015, Home Depot has hiked its dividends per share from $2.56 to $5.44 per share in 2019. This is a rise of 130.5% in just four years. That represents an average annual increase of 23.2% per year.
You can see the huge growth in Home Depot’s dividends per share over the past 10 years in the chart below.
What HD Stock Is Worth Based on Expected Dividend Growth
On Feb. 25, 2020, Home Depot will announce the quarterly dividend for the next year. If the trend were to continue, the dividend may be set as high as $6.70 per share, up from $5.44 per share today. That would be an increase of 23.2%, the average of the past four years.
Even if the dividend is set 20% above the prior year, the dividend per share will be $6.53 per share. This would represent a payout of just 62% of its expected 2020 earnings of $10.55 per share.
Moreover, Home Depot stock has had an average dividend yield of 2.36% over the past year. Therefore, taking the estimated dividend of $6.53 per share and dividing it by 2.36% brings an expected price of $276.79. This is 13% higher than today’s price of $245.03.
But if we were to use the higher expected dividend, based on the average 23.2% rate increase in the past four years, the resulting expected price is $283.90. That price represents a gain of 15.9% over today’s price.
Summary and Conclusion
Why is this important? Remember how I pointed out that the total return for Home Depot stock in 2019 was over 23.8%? That was a direct result of Home Depot hiking its dividend per share last year over 32% (see the chart above).
As a result, one can expect that Home Depot’s earnings announcement will be very important for the rate at which it decides to hike the dividend. The dividend raise will have a direct impact on the expected gain in Home Depot stock this coming year.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers receive a two-week free trial.