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Home Depot’s Financial Engineering Boosts Returns Metrics

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The exponential rise in Home Depot’s return on equity

Besides the upbeat earnings we discussed earlier in the series, Home Depot (HD) also significantly increased its returns metrics. HD’s ROE rose from 12.7% in fiscal 2009 to nearly 90% in fiscal 2016. Although the company generates significant amounts of cash flow, it’s been employing leverage to buy back its own shares and enhance shareholder return on equity (or ROE).

Home Depot generated $7.9 billion in free cash flow in fiscal 2016. The company bought back shares worth $7 billion and paid dividends of $3 billion. The cash shortfall, along with the Interline acquisition, was debt financed. Debt increased by $4.1 billion in the year. The use of cheaper debt in the financing structure has magnified the ROE. Other returns metrics like ROIC (return on invested capital) and ROA (return on assets) are also up due to higher capital efficiency and improved margins.

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Stock market reaction

Home Depot’s (HD) stock price rose 1.4% to close at $124.53 on February 23, the day the company declared fourth quarter earnings for fiscal 2016. As discussed earlier on in the series, the retailer’s results beat the market consensus on both revenue and earnings, and also exceeded the company’s guidance provided earlier.

In contrast, Lowe’s (LOW), which declares results for fiscal 2016 on February 24, was down 2.3% to $67.90. Other competitors that also fell on the day included Bed Bath & Beyond (BBBY), which was down 0.42%, and Williams-Sonoma (WSM), which was down 0.93%. The Dow Jones Industrial Average (DIA) was down 1.1% while the S&P 500 Index (SPY) (IVV) (VOO) fell by 1.3%.

Stocks that were up included Pier 1 Imports (PIR), which was up 4.2%, and Wayfair (W), which was up 1.9%. The iShares U.S. Home Construction ETF (ITB) and the SPDR S&P Homebuilders ETF (XHB) were up by 0.76% and 0.30%, respectively.

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