Valuation multiples help investors make investment decisions and are driven by investors’ willingness to pay, perceived growth, risks, and uncertainties.
We’ll use the forward PE (price-to-earnings) multiple for this analysis, given Home Depot’s (HD) high earnings visibility. The forward PE multiple is calculated by dividing a company’s current share price by its EPS (earnings per share) forecast for the next 12 months.
Home Depot’s PE multiple
The rise in the housing price index, the higher housing turnover, and its better-than-expected 4Q16 earnings all appear to have increased investor confidence in HD, leading to a rise in its stock price as well as its PE multiple. As of April 27, 2017, Home Depot was trading at a forward PE multiple of 21.1x, as compared to 19.9x before the announcement of its 4Q16 earnings.
Home Depot is now trading at a higher valuation multiple than the peer median. As a leader in the home improvement sector, Home Depot enjoys greater revenue growth and expansion of its margins, which has allowed the company to trade at higher multiple.
Analysts are now expecting Home Depot to post EPS growth of 11.5% in 2017, and HD’s current stock price might have factored in this EPS growth. But if the company posts earnings that are lower than expected, selling pressure could lower the company’s valuation multiple.
You can mitigate these company specific risks by investing in the SPDR Dow Jones Industrial Average ETF (DIA), which has 5.02% of its holdings in Home Depot.
Now let’s look at the analysts’ recommendations and target prices.