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Home Depot could hit a home run that would build big profits

Dear Mr. Berko: I’ve owned stock in The Home Depot Inc.
since May 2006. My broker said the stock would run sky-high because the real
estate market was going gangbusters. I paid $39.40 a share for 600 shares, and
I now have an 11-point loss.

Dear Mr. Berko: I’ve owned stock in The Home Depot Inc.
since May 2006. My broker said the stock would run sky-high because the real
estate market was going gangbusters. I paid $39.40 a share for 600 shares, and
I now have an 11-point loss.

Now my broker wants me to sell my 600 shares and put the
money in the American Funds, which has an excellent long-term growth record.

I’m not sure this is the right time to sell Home Depot, even
though its revenue and earnings were down quite a bit last year.

But my broker makes a good case, telling me that the
slowdown in home building will last for a couple of years. He persuasively
tells me that the building market is actually going to crash, that there is
little new mortgage money available, and demand for home-building products is
drying up. He thinks Home Depot could fall as low as $17; he makes a lot of
common sense to me.

W.P.

Durham, N.C.

 

Dear W.P.: Most folks define common sense as being able to
see clearly what is in front of your eyes. But I define common sense as the
capacity to see clearly what is in front of another person’s eyes.

In the eyes of that other person, I see him buying a new
bathroom sink, roofing materials, appliances, windows, etc. In that other
person’s eyes, I can see that he can’t sell his house and that it’s a lot
cheaper to remodel his current home than to buy a new one. His spouse wants a
second bath or half-bath, or new doors, new appliances, or a family room or a
pool, etc. And there are a lot of unemployed skilled carpenters, electricians,
plumbers, etc., who will do that work for a lot less money than they would have
billed for it 18 months ago. In many cases, the husband has enough skills to
complete a lot of the work himself. So that translates into higher revenue, as
well as improved earnings, for The Home Depot Inc. (HD-$28) and for Lowe’s
Companies Inc. (LOW-$24). This improvement won’t be a dramatic change; rather,
it will be a slow and deliberate effect.

One of the best things to happen to HD was the departure of
Robert Nardelli, the bane of most store managers in the HD chain of 2,200
locations. Nardelli’s management style didn’t go over well with HD people, and
he was kind of asked to resign. He did in January 2007, and by August, he found
himself a position as chief executive officer of Chrysler.

Ah … those poor Chryslerites; they’re going to be in for a
brutal awakening as he garrotes most of the administrative staff.

The next-best thing to happen to HD is the arrival of Frank
Blake, the company’s new chairman, chief executive officer and president. I’m
told that Blake has “heart and common sense.” Blake sold HD Supply
for $9 billion (good riddance) and will use those funds to repurchase
outstanding shares. Blake is also backing HD’s commitment to the retail
customer via aggressive reinvestment in HD stores. The business is upgrading
its units, refining its supply chain, adding full-time sales help, recruiting
skilled trade specialists and working hard to improve customer service. These
are things that Nardelli considered unimportant. Yep! That’s right!

HD is the largest and some people say the best
home-improvement retailer south of the North Pole. Management is adding some
rather exclusive and fascinating merchandise that will impressively separate
itself from other retailers. HD’s installation business is expanding quite
nicely, and its multilevel stores in urban locations like New
York City and Chicago
have been growing impressive results.

Revenue for this year should improve by about 3 percent, to
$81 billion, while earnings may increase 20 percent, to $2.71 a share from last
year’s $2.30.

Even though I don’t expect to see a strong increase in
revenue, I do expect to see a good increase in earnings as Blake wisely
improves upon HD’s efficiencies. HD has an impressive cash flow, which supports
continued dividend increase and will assist the new CEO in funding a large
share buyback program.

Meanwhile, there are six “strong buy”
recommendations on HD; however, considering the names, I don’t trust the
methods they used – though I do agree with their conclusions.

If I were you, I would buy another 600 shares of HD at
today’s price, then wait 31 days, sell the 600 shares you purchased at $39, and
take a tax loss. This would give you a new basis of $28. And in the coming
three to four years, I would think that HD could trade in the high $50s to low
$60s.

Meanwhile, I like American Funds with its excellent
management team. It’s among the top performing fund groups and has a superb long-term
performance record.

But I’m not comfortable with American Funds’ 5 percent
commission costs. There are no-load funds with similar to better records that
I’d more readily recommend. The Bruce Fund, several funds in the Fidelity
Group, T. Rowe Price Group and Dodge & Cox to name a few.

Malcolm Berko responds to letters he receives; send
questions to Berko, c/o Central Penn Business Journal, P.O. Box 1416, Boca Raton,
FL 33429.
He answers questions by mail or in his column for free. If readers want in-depth
analyses, they may be asked to become clients.

©Copley News Service

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