HOme Depot

Case Analysis Of Home Depot Inc.In The New Millennium03. Jun, 2013

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Case Background

COMPANY HISTORY

Home Depot Inc., the largest retailer of home improvement products and third largest retailer in United States was

established in 1978 in Atlanta, Georgia. The company revolutionized the do-it-yourself market in the United States.

The stores of the company were warehouses and they sold large volume of goods at low prices. This company was

regarded as the only company that successfully brought off the union of low prices and high service.

The financial and operating performance had been extraordinary throughout the decade of 1990s.The stock price and

earnings per share had risen dramatically over the years. At the end of the decade this company was the largest

home improvement retailer in the country and was planning to grow the number of stores.

Home Depot, Inc. was a growing company in a growing industry of home improvement products which cannot be

drastically affected by economic vicissitudes. In the industry of home improvement products retailers this company

had several well operated competitors. But being the largest and competent retailer Home Depot occupied the largest

market share among them. The company pursued several growth initiatives to enlarge its market share and generate

higher growth in earnings such as going after professional customers, changing store formats, adding to its product

line, developing Internet business; which were associated with some risks as well.

CURRENT SITUATION

On October 12, 2000 the company announced that its earnings in the last two quarter of the year will be good deal

lower than expected. And as a result the Company’s stock price experienced a one day drop of 28 percent causing a

decline in the market value of the firm by $33 billion. The fall in the price of this company caused the stock prices of

other retailers of the kind to fall as well.

The U.S. economy had a continuous growth since 1992 but the interest rate was raised for a total of 1.75 percent

point which caused the softening of consumer demand. Home Depot, Inc. was not recession proof but the nature of

its business protected it from being vulnerable to economic variability.

The decline in the stock price was primarily thought as the result of slowing economy but because of the nature of the

business and growth initiatives undertaken it was not clear whether the phenomenon was primarily a function of

slowing economy, a reaction to overvaluation of the stock or a reflection of possible problems with the company’s

strategy for future.

Framework of Analysis:

The analysis part of this case can be segregated into four major sections:

1. Economic Analysis

2. Industry Analysis

3. Company Analysis and

4. Scenario Analysis

Economic Analysis – the first step of top-down approach of valuation process – has been done by addressing the

following issues:

· The U.S. economy

· The Home Improvement Market

· Inflation, Interest Rates and Stock Values

· Estimation of Market Return (Rm)

The Industry Analysis includes:

· Competitor’s Analysis

· Porter’s Five Forces Model

The Company Analysis has been done in 6 major parts, consistent with the case requirements. They are:

· SWOT Analysis:

o Involves an examination of a company’s strengths, weaknesses, opportunities and threats.

· Financial Statements Forecast:

o Includes the forecasted income statement and balance sheet of Home Depot, Inc. for year ending in January 2oo1.

· Ratio Analysis:

o The areas of ratio analysis are Profitability, Leverage, Asset utilization & Liquidity ratios.

· DuPont Analysis:

o DuPont analysis is an expression which breaks ROE (Return on Equity) into three parts. This analysis enables the

analyst to understand the source of superior (or inferior) return.

· Risk analysis:

o Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital.

The total risk of the firm has two internal components-

Business Risk:

Business Risk is usually measured by the variability of firm’s operating income over time. Other useful measures of

business risk are:

o Sales Variability

o Operating Leverage

Financial Risk:

Financial Risk is the additional uncertainty of returns to equity holders due to a firm’s use of fixed financial obligations.

It can be measured by different leverage ratios and coverage ratios, such as:

o Financial leverage ratios

o Interest coverage ratio

o Cash flow to total debt

· Determination of Home Depot, Inc.’s Intrinsic Stock Value

Problem Statement- Determining the reasons of the company’s stock price decline.

The Scenario Analysis is a process of analyzing possible future events by considering alternative possible

outcomes (scenarios). Here we considered three possible scenarios for Home Depot, Inc.’s intrinsic stock value by

taking their growth plans into account. The scenarios are:

o The Optimistic Case,

o The Pessimistic Case and

o The Most Likely Case

Economic analysis:

Economic analysis is done to find out the general influences of aggregate economy or market that can significantly

impact the returns for an individual stock. Studies have found a relationship between aggregate stock prices and

various economic series such as employment, income, inflation or production. Therefore when assessing the future

value of a security, it is necessary to analyze the outlook for the aggregate economy.

In our economic analysis for Home Depot, Inc. we will enumerate the situation of both the US economy and the home

improvement market.

The U.S. economy:

The U.S. economy had experienced uninterrupted growth since 1992. Between June 1999 and May 2000, however

the Federal Reserve had raised interest rates six times—for a total of 1.75 percentage point—in an effort to slow

down the economy. This measures have resulted in somewhat lessening of overall consumer demand.

The Home Improvement Market:

Since 1981 till now, the home improvement industry in the U.S. had grown at an annual rate of about 6%, or slightly

slower than the U.S. economy as a whole. However, with the expectation of some decline in the economy,

economists predict an average nominal growth in the industry.

Following is the Home Improvement Research Institute’s projection of growth in U.S. market for home improvement

products:

YearPercent Change over Previous Year20006.3%20013.2%20024.0%20034.4%20044.6%During the recent years, several factors such as, low interest rate, strong housing turnover, rising home ownership,

and increases in disposable income has helped the home improvement industry to grow at a decent rate. But from

March 1994 through February 1995, 30-year mortgage interest rates increased by an average of 24%. In May 2000,

they had climbed to 8.6%, before falling a bit below 8% in the fall. Since Home Depot, Inc. has grown to occupy a

large share of the market, these macroeconomic changes are going to have far greater impact on them.

Inflation, Interest Rates and Stock Values:

Although the relationship between inflation, interest rates and stock values is not direct and consistent the cash flows

from stocks can change along with inflation and interest rates. If the interest rates rise due to an increase in the rate

of inflation it is assumed that the corporate earnings likewise experience an increase in growth because the firms are

able to increase prices in line with cost increase. In such case stock price can be fairly stable because the negative

effect of an increase in required rate of return is partially or wholly offset by the increase in growth, which means that

the return on stock increase in line with the rate of inflation.

Estimation of Market Return (Rm):

To conduct an economic analysis it is important to estimate the rate of return of the market. The rate of return is the

function of nominal risk free rate and market risk premium and here a range of values are used for the risk premium.

The alternatives for NRFR are based upon the specification that it should be zero coupon, default free asset with a

maturity that approximates the investor’s holding period. In this case there are different maturity Treasury securities

yields given as of early October 2000 such as:

Maturity Yield1 month 6.00%3 Months 6.08%1 year 6.18%5-10 years5.8%30 years 5.83%In determining the risk free rate the belief is reflected that the typical investment horizon is longer than that implied by

the bill. Assuming that most investors consider the intermediate time frame (5-10 years) a more appropriate

investment horizon 5.8% is considered as the nominal risk-free rate.

Studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% while using the current

intermediary government bond rate as the estimate of the minimal NRFR. So on this case the market risk premium is

determined within this range.

Industry Analysis

Industry analysis is done because it determines a firm’s business risk due to sales volatility and operating leverage

and its profitability is impacted by competitive environment in the industry. Home Depot, Inc. is in an industry which is

not susceptible to business cycle and consists of many other competitive home improvement firms. The major players

in the home improvement industry in this case are described in the competitor’s analysis.

COMPETITOR’S ANALYSIS

Home Depot, Inc.:

Home Depot is the largest retailer of home improvement products and third largest retailer of any sort in United

States. Home Depot had competencies that very few other retailers had and was one of the most successful retailers

in American history. This company opened stores containing a huge assortment of building materials and home

improvement products and that targeted individual homeowners and small contractors. The stores were warehouses

and they sold large volumes of goods at low prices and they also provided knowledgeable customer services. At the

end of 1999 was the largest home improvement retailer with a market share close to 24 percent and operated 930

stores with 21-22 percent growth in stores. After including the professional customers and heavy industrial sector in

the company’s market of residential home repair and remodeling by do-it-yourself it estimated its market share 8.9

percent.

Lowe’s:

Among the home improvement retailers Home Depot’s principal competitor was Lowe’s and it was about half the size

of Home Depot. It had annual sales of $16 billion and a market share of 10 percent. It operated 578 stores and

planned to add more in the succeeding year. Lowe’s began to operate in rural towns with small stores and later it

began to copy Hope Depot’s model, opening huge, warehouse-type stores in metropolitan markets along with special

services for its customers. It sold some product lines that Home Depot did not and also tried to appeal more to

women shoppers, with wider aisles and brighter lightning than Home Depot. In certain markets Lowe’s went on a

though competition with Home Depot.

Mernards:

The next largest, Mernards was far smaller but geographically more focused. It had annual sales of about $4 billion

and a market share of 2.5 percent, operated solely in several Midwestern states and was said to have a loyal

customer base. In some areas Mernards had greater market share than that of Home Depot.

HomeBase:

HomeBase had annual sales of about $1.5 billion and a market share of 1 percent, operated solely in several western

states. Its stores were as large as Home Depot’s and in certain areas it had a number of stores compared to Home

Depot’s.

Hechinger:

Initially Home Depot’s most important competitor was Hechinger which was considered the premium home

9improvement chain and were known for very good customer services. When it tried to follow Home Depot’s

warehouse format it lost out in market by market and in 1999 it went out of business.

PORTER’S FIVE FORCES ANALYSIS

Porter’s five forces is a framework for the industry analysis and business strategy development developed to derive

five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this

context refers to the overall industry profitability.

The threat of the entry of new competitors:

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually

will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the

abnormal profit rate will fall towards zero. The home improvement product industry is not susceptible to business

cycle and is fairly protected from the vicissitudes of the economy. This industry has a growing potential making it an

attractive profitable industry to start business and the more profitable the industry the more attractive it will be to new

competitors. The government also does not have restricted policies for this industry which makes the entry barriers

low. So, there is a threat of new entrants to the existing firms.

The intensity of competitive rivalry:

There are few home improvement product retailers in the whole industry so the degree of rivalry is moderate.

Competitive rivalry is likely to be based on dimensions such as price, quality, and innovation. Technological advances

protect companies from competition. Undertaking initiatives such as shifting to a different customer strategy, widening

product categories, changing store formats, expanding the business internationally and initiating internet sales, a firm

can have competitive advantage until other firms imitate it. Although the customer’s switching cost is low the market

growth and increasing demand allows firms to match their expected sales and attract new customers and it is the

growth in the market that decreases the degree of rivalry.

The threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of

customers to switch to alternatives. For individual homeowners and professional customers such as contractors,

electricians, plumbers, landscapers, property maintenance managers etc. there are no alternatives to home

improvement products to repair homes and operating business respectively. Although the professional segment is apt

to business cycle the threat of substitution products or services is very low in this industry.

The bargaining power of customers

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm

under pressure, which also affects the customer’s sensitivity to price changes. In the industry there are several

retailers of home improvement products which leave customers with a lot of options for choosing. There is also a

large number of customers for the home improvement products which lowers the bargaining power of the customers.

The bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components,

labor, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers may refuse to

work with the firm, or, charge excessively high prices for unique resources. In this case the retailers of home

improvement products are not dependent on one or few suppliers. They have a lot of suppliers in US for purchasing

the materials. So the suppler switching cost for the retailers is low which reduces supplier’s bargaining power.

Company Analysis:

For company analysis of Home Depot, Inc. we discuss the SWOT analysis, Financial Statements forecast, ratio

analysis and DuPont Analysis.

SWOT ANALYSIS

SWOT analysis involves an examination of a company’s strengths, weaknesses, opportunities and threats. Strengths

and weaknesses involve identifying the firm’s internal abilities or lacks thereof. Opportunities and threats include

external situations such as competitive forces, discovery and development of new technologies, government

regulations and domestic and international economic trends. In this section we would present the SWOT analysis for

Home Depot, Inc.

STRENGTHS

Home Depot, Inc. is the Largest Retailer of home improvement products. One of the most prominent features of

Home Depot, Inc. that sets them apart from the rest of the industry is their superior customer service. Since

beginning, Home Depot, Inc. was the only company that was known for its knowledgeable customer service. The

company had built a strong base of trained employees through making the product knowledge training classes

mandatory for all its salespeople. Home Depot, Inc. also provides special services such as renting trucks, propriety

credit cards, provision for unsecured loans to make large purchase and brief courses (how-to clinics) to help

customers in carrying out projects. There were also longer, four-week courses that were called Home Depot

University.

Another exceptional strength of Home Depot, Inc. is its ability to sustain extraordinary financial and operating

performance over the years. The company’s stock price had also risen dramatically. Between the fall of 1981 & End

of 1999, stock price had risen at a compound annual rate of 29%.

Constantly evolving management style has proved to be a great strength of Home Depot, Inc. the company never

seems to regard the way it operate as settled. The management evaluates new ideas on smaller scale before taking

to entire store network.

One of Home Depot, Inc.’s potency is the ability to successfully utilize its capability through furtherexpansion of

operations and growth initiatives. They are planning on increasing the no. of stores annually by 21-22 percent so

that by the end of 2003 the store no. will be over 1900. Redefining its industry has resulted in product sales to

professional customers in addition to do-it-yourself (D-I-Y) customers. By 1999, Home Depot, Inc. increased its

market share of professional customer sector from 4% to approximately 8.9%. Among growth initiatives Home Depot,

Inc. is pursuing the likes of shifting to Triple Customer Strategy, Store Format Changes, Product Category Expansion,

International Growth, and Internet Sales.

WEAKNESSES

Home Depot, Inc. was primarily involved in selling materials that ordinary people use for home improvement projects.

But over the past years it has grown significantly. The growth plans point out some potential weaknesses of the

company.

Satisfying the need of different customer groups is indeed a strenuous task. It has been observed that many other

companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. Many

regional wholesalers of electrical products, serving the professional customers, claim to offer better services than

Home Depot, Inc. in terms of broader and deeper inventory, more knowledgeable sales help, and reliable delivery.

Another likely problem of the company is its inability to effectively handle Cross-Selling. To be successful in this

feat the Home Depot, Inc. must be able to properly integrate different products within a given organizational structure.

OPPORTUNITIES

The proposed growth schemes present certain opportunities for the company. Redefining their market and shifting

from D-I-Y to triple customer strategy is going to create more opportunity enhance the scope of Home Depot, Inc.’s

operations and market presence.

Buy-it-Yourself (B-I-Y) Customers has opened the window for serving the new Market for installation services. The

total U.S. market for this category is estimated at $75 billion. Home Depot, Inc. serves less than 2% of this market but

plans to grow by 40% each year for the next five years.

Serving Professional Customers provides a Large Market potential and great propensity for Repeat Business. This

strategy is anticipated to influence sales the most out of all of the initiatives.

Changing Product Categories would help in increasing product line, adding appliances to complement current

offerings and vertically integrate supply chain.

International growth initiative is believed to be very important in the next five to fifteen years as it would allow the

company to expand its realm of market presence globally.

The company also intends to possess the “world’s largest e-commerce” site in the industry through its process of

developing its Internet Site.

THREATS

Along with the opportunities, the growth initiatives pose many threats to Home Depot, Inc.’s overall financial and

operating performance as well. Moreover, macroeconomic factors have a greater impact on the company than before

since it has gained a much larger portion of market share and increased its products and services.

Home Depot, Inc. was thought to be fairly protected from the vicissitudes of the economy. . Since Home Depot, Inc.

has grown to occupy a large share of the market, the company has become much vulnerable to these

macroeconomic changes. The U.S. economy had experienced uninterrupted growth since 1992. Between June

1999 and May 2000, however the Federal Reserve had raised interest rates six times—for a total of 1.75 percentage

point—in an effort to slow down the economy. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in

the fall. This has been marked as the main reason the company’s earnings shortfall.

Another threat is the possibility of over-saturation of certain big city-markets. Home Depot, Inc. and its biggest

competitor, Lowe’s are both planning on opening a lot of new stores in the next few years. This poses the threat of

excess supply and falling of prices.

As Home Depot, Inc. plans to double the number of stores over the next 4 years, it is uncertain if the will be able

to uphold its reputation for having the best customer service and most efficient employees.

Moreover, the professional segment and the Expo Design Center stores are going to be more sensitive to cyclical

changes in the economy.

The international growth scheme presents the most complex challenges because of real estate, and logistics of

the supply chain as well as the barriers of language and cultural differences.

FINANCIAL STATEMENTS ANALYSIS

The income statement and balance sheet of Home Depot, Inc. has been forecasted for year ending in January 2oo1.

For this purpose following assumptions have been made.

· Sales have increased at a rate of 21%

· Operating expenses and operating profit will increase by the same percentage

· Assume that cash will increase at 21% per year

· Accounts receivable and inventories will also increase by the same percentage

· Assume accounts payable and other accrued liabilities will increase by 21% per year

· Total Debt and equity has been calculated in consistent with previous year’s debt to capital and debt to equity ratio.

· Long term debt has been kept same as previous year but interest expense has been increased by 1.75 percent

points.

· Sighting a 21% annual growth of store number in future years, the property and equipments has been increased by

that rate.

· Common Stock, Paid in Capital & Retained Earnings have been calculated in consistent with previous year’s ratio

with total capital.

Income Statement

Home Depot, Inc.

Years ending JanuaryYear 1999 2000 2001

(Forecasted)Net sales 302193843446505Cost of merchandise sold 216142702332788Gross Profit 8605 1141113717Operating expensesSelling and store operating 5341 6832 8265Pre-opening 88 113 136General and Administrative 515 671 872Non-Recurring chargeTotal Operating Expenses 5944 7616 9273Operating Income 2661 3795 4444Interest and Investment Income 30 37 38Interest Expense 37 28 28Interest, net 7 9 10Earnings Before Income Taxes(39% Tax Rate)2654 3804 4454Income Taxes 1040 1484 1737Net Earnings 1614 2320 2717Diluted EPS 0.71 1.00 1.16Balance Sheet

Years ending JanuaryYear 1999 2000 2001ASSETS (Forecasted)cash & equivalents 62 168 203.38short term investments 2 2receivables 469 587 710.27Merchandise Inventories 4293 5489 6641.69Current Assets 109 144 174.24

Total Current Asset 4933 6390 7731.58Properties & Equipmentland 2739 3248 3930.08Buildings 3757 4834 5849.14Furniture 1761 2279 2757.59Leasehold 419 493 596.53Construction in progress 540 791 957.11Capital lease 206 245 296.45

9422 1189014386.9Less: Accumulated depreciation 1262 1663 2014.166

Net Properties & Equipment 8160 1022712372.73

Costs in excess of Fair value 268 311 376.31others 104 153 185.13

TOTAL ASSETS 134651708120665.75LIABILITIES AND STOCKHOLDERS’ EQUITYAccounts Payable 1586 1993 2411.53Accrued Salaries 395 541 697.89Sales Tax 176 269 325.49Other Accrued Expense 586 763 984.27income tax payable 100 61 71.37Current part of Long term Debt 14 29 90.08396

Total Current Liabilities 2857 3656 4580.634long term debt 1566 750 750Other Accrued Expense 208 237 286.77Deferred Income 85 87 105.27Minority Interest 9 10 12.1

Total Long term Debt 1868 1084 1154.14Stockholders’ EquityCommon Stock 111 115 139.1348Paid in Capital 2817 4319 5225.42Retained Earnings 5876 7941 9607.561Other -64 -34 267.1

TOTAL STOCKHOLDERS’ EQUITY 8740 1234114930.98

Total Liabilities & Stock holder’s Equity 134651708120665.75RATIO ANALYSIS

From above financial statements following ratios can be found.

year 1999 2000 2001ProfitabilityProfit Margin (%) 6.00% 6.04% 5.84%Return on equity (%) 26.13%24.94%18.20%Return on assets (%) 22.20%18.02%13.15%LeverageDebt/Equity Ratio 0.54 0.38 0.38Debt/Total capital 0.35 0.28 0.28Asset utilizationSales/Assets 3.7 2.99 2.25LiquidityCurrent ratio 1.73 1.75 1.75The profitability ratios show a fall in profit growth in the forecasted year. The debt-to-equity ratio (D/E) is a

financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets.

The debt-to-capital ratio gives users an idea of a company’s financial structure, or how it is financing its operations,

along with some insight into its financial strength. The higher the debt-to-capital ratio, the more debt the company has

compared to its equity. Home Depot, Inc. remains free of too much debt burden. The current ratio is a financial ratio

that measures whether or not a firm has enough resources to pay its debts over the next 12 months. Home Depot,

Inc. can cover all of its current obligations with its current assets efficiently96

DUPONT ANALYSIS

DuPont analysis is an expression which breaks ROE (Return On Equity) into three parts. This analysis enables the

analyst to understand the source of superior (or inferior) return.

ROE = (Profit margin)*(Asset turnover)*(Equity multiplier)

= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)

= (Net Profit/Equity)

DuPont analysis tells us that ROE is affected by three things:

- Operating efficiency, which is measured by profit margin

- Asset use efficiency, which is measured by total asset turnover

- Financial leverage, which is measured by the equity multiplier

The DuPont Break down of Home Depot, Inc

profit marginasset turnoverequity multiplierROE Operating ROA20005.84% 2.25 1.38 18.20%13.15%19996.00% 3.70 1.18 26.13%22.20%19985.40% 3.70 1.14 22.70%19.98%19974.80% 3.60 1.13 19.50%17.28%19964.80% 3.50 1.12 18.80%16.80%19954.70% 3.50 1.29 21.30%16.45%19944.90% 3.80 1.15 21.50%18.62%19934.70% 3.40 1.25 19.90%15.98%19924.80% 4.60 0.97 21.50%22.08%19914.70% 4.80 1.62 36.50%22.56%19904.40% 5.60 1.29 31.90%24.64%19894.10% 5.80 1.23 29.20%23.78%19883.90% 5.80 1.06 23.90%22.62%19873.80% 5.50 1.59 33.20%20.90%19862.90% 3.50 2.64 26.80%10.15%Return on Equity

Return on Equity measures the rate of return on the ownership interest (shareholders’ equity) of the common stock

owners. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity (also known as net

assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings

growth. Home Depot, Inc. has had a decent to high return on equity ranging from 18.80% to 36.50%. Our forecasted

ROE for year 2000 shows a fall in ROE from 26.13% to 18.20%.

Profit Margin:

The profit margin of Home Depot, Inc. has been steadily growing over the years. The forecasted profit margin for year

ending in 2001 shows a slight decrease from 6% to 5.84%.

Asset Turnover:

Asset turnover is a financial ratio that measures the efficiency of a company’s use of its assets in generating sales

revenue or sales income to the company. The higher the number the better. Home Depot, Inc.’s Asset Turnover has

been high in the initial years but slowed down in the recent years, which is reflected in the slowing down of ROE after

the initial years. The forecasted turnover drops to 2.25 from previous years 3.7.

Equity Multiplier:

The company’s leverage ratio (Assets ÷ Equity), which is equal to the firm’s debt to equity ratio + 1. This is a

measure of financial leverage.

Except for the 1st year, company’s equity multiplier has been pretty decent, which means Home Depot, Inc. has been

fairly independent in managing their own financing.

Return on Assets

The return on assets (ROA) percentage shows how profitable a company’s assets are in generating

revenue. This tells us what the company can do with what it has, i.e. how many dollars of earnings they derive

from each dollar of assets they control. Home Depot, Inc. has had a decent to high return on Asset ranging from

10.15% to 24.64%. Forecasted ROA for year ending in 2001, drops to 13.15%.

RISK ANALYSIS

Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital. The

typical approach examines the major factors that cause a firm’s income flow to vary. More volatile income flows mean

greater risk.

The total risk of the firm has two internal components- Business Risk & Financial Risk.

Business Risk:

Business Risk is the uncertainty of operating income caused by firm’s industry. It is usually measured by the

variability of firm’s operating income over time.

Business Risk = ƒ (Coefficient of Variation of Operating Earning)

The business risk of Home Depot, Inc. is calculated below.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999NOPAT$167 $240 $346 $439 $609 $722 $932 $1159 $1618 $2315

Sales $3815$5137$7148 $9239$12477$15470

$19535 $24156$30219$38434

Standard Deviation Of NOPAT = $ 681.0143Mean of NOPAT = $854.7CV of NOPAT = 0.796788Besides overall Business Risk, it is insightful to examine other factors that contribute to operating earnings.

Sales Variability:

Sales variability is the prime determinant of operating income variability. The variability of sales is mainly caused by

firm’s industry and is largely outside control of management.

Sales Variability = ƒ (Coefficient of Variation of Sales)

The Sales variability of Home Depot, Inc. is calculated below.

Standard Deviation Of Sales =$11472.44Mean of Sales = $16563CV of sales= 0.692655OPERATING LEVERAGE

The variability of firm’s operating income also depends on its mixture of production cost. Fixed production cost

causes operating profit to vary more than sales over business cycle. The employment of fixed production cost is

called operating leverage. Greater operating leverage causes greater earning volatility.

Operating Leverage =

The operating leverage of Home Depot, Inc. is calculated below

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999NOPAT $167.00 $240.00 $346.00 $439.00 $609.00 $722.00 $932.00 $1,159.00 $1,618.00 $2,315.00%change $0.46 $0.44 $0.44 $0.27 $0.39 $0.19 $0.29 $0.24 $0.40 $0.43

sales$3,815.00

$5,137.00

$7,148.00

$9,239.00

$12,477.00

$15,470.00

$19,535.00

$24,156.00

$30,219.00

$38,434.00

%change $ 0.38 $0.35 $0.39 $0.29 $0.35 $0.24 $0.26 $0.24 $0.25 $0.27Operating Leverage =1.169905This means, if sales of Home Depot, Inc. increases (decreases) by 10% its earnings (NOPAT) will increase

(decrease) by 10% X 1.1699 = 11.699%. It can be said that the risks resulting from operating leverage in Home

Depot, Inc. is not much.

Financial Risk:

Financial Risk is the additional uncertainty of returns to equity holders due to a firm’s use of fixed financial obligations.

A higher proportion of debt capital compared to equity capital makes earnings more volatile and increase probability

of default.

It can be measured by different leverage ratios and coverage ratios. The Financial Risk of Home Depot, Inc. is

calculated below-

year 1999 2000 2001Financial LeverageDebt/Equity Ratio 0.54 0.38 0.38Debt/Total capital (%)0.35 0.28 0.28Coverage Ratio

Interest Coverage 71.92135.54 158.71

Cash Flow-Total Debt1.0192.198 2.196The financial leverage ratios of Home Depot, Inc. demonstrates that they have used smaller amount of debt and more

equity in financing, which reduces earning volatility for equity holders and results in lower default risk.

Interest coverage ratio indicates fixed interest charges are earned, based on the earnings available to pay these

expenses. Home Depot, Inc. is in a healthy position to clear these charges.

Another coverage ratio- Cash flow to total debt relates cash flow to firm’s total outstanding debt. The higher this ratio,

the stronger the company- i.e., the lower its financial risk. In this regard too, Home Depot, Inc. is in a strong position.

DETERMINATION OF HOME DEPOT,INC.’S INTRINSIC STOCK VALUE

The calculation of Home Depot, Inc.’s stock price for February 1, 2001 requires completing the following steps:

Step 1: Drawing the Assumptions:

We develop the following assumptions based on realistic inference from Home Depot, Inc.’s current state and future

prospects:

1. Risk free rate (RF) of 5.8% which is equal to the yields on 10 years treasury securities.

2. Risk Premium (RM-RF) of 3.00%

3. Four-stage growth model:

Multi-Stage Growth RatesYear Dividend Growth Rate (g)2001-2002 g1=16%2003-2005 g2=23%2006-2009 g3=18%2010 onwardsg4=8%Step 2: Calculating the Cost of Equity Capital (rs) using Security Market Line (SML):

The formula for SML is:

rs= RF + β * ( RM – RF) = 9.07%

Where, RF = 5.80%

RM = 8.80%

RF = 5.80% (yields on 10 years treasury securities)

(RM – RF)=3.00%

β HDI = 1.09

Step 3: Determining the intrinsic value by using extended DDM model:

In our assumption of multiple growth rate model, the growth rate rises sharply after the first two years then gradually

declines to the constant perpetual growth of 8.00%. To get the value, the initial years are examined individually. Then

the remaining value of the firm is computed assuming the constant growth using the DDM which is in turn discounted

to get the present value. We assumed that,

Here, D/E = 11% which is constant over the periods included in valuation.

Where, D0 = $0.13 & EPS0 = $1.16

The detailed calculation is given below:

Period 1 2 3 4 5 6 7 8 9 10

Diluted EPS $ 1.35$ 1.56$ 1.92 $ 2.36

$ 2.90 $ 3.43$ 4.04

$ 4.77 $ 5.63$ 6.08

Dividends $ 0.15$ 0.17$ 0.21 $ 0.26

$ 0.32 $ 0.38$ 0.44

$ 0.52 $ 0.62$ 0.67

Discounted Dividends$ 0.14$ 0.14$ 0.16 $ 0.18

$ 0.21 $ 0.22$ 0.24

$ 0.26 $ 0.28$ 28.61

Our calculated value of stock as of February 1, 2001 was, VS = $30.45

Assumptions Leading to Market Value of $48.20

In an efficient market security prices adjust quickly to the arrival of new information and the current prices of

securities reflect all information about the security. This market allocates fund to their most productive uses as a

result of competition among the wealth maximizing investors and determines and publicizes prices that are believed

to be close to their true value.

On February 1, 2001 the market value of the stock of Home Depot was $48.20, which was far different from the

intrinsic value. This means information about the security is not fully reflected on the price. Much higher return on

equity and therefore higher growth rate is consistent with this price keeping the cost of equity constant however.

Multi-Stage Growth RatesYear Dividend Growth Rate (g)ROE2001-2005 g1=29% 32.5%2006-2009 g2=28% 31.46%2010 onwardsg3=8% 8.98%

If the growth rate is assumed to be an average of 29% for nearly a decade as the decade of 1990s and the constant

growth rate of assumed to be 8% with constant cost of capital of 9.07% the intrinsic value will be close to $48.20. The

detailed calculation is as follows:

Period 1 2 3 4 5 6 7 8 9 10

Diluted EPS $ 1.35 $ 1.56$ 2.01$ 2.60 $ 3.35$ 4.29$ 5.49

$ 7.02 $ 8.99$ 9.71

Dividends $ 0.15 $ 0.17$ 0.22$ 0.29 $ 0.37$ 0.47$ 0.60

$ 0.77 $ 0.99$ 1.07

Discounted Dividends$ 0.14 $ 0.14$ 0.17$ 0.20 $ 0.24$ 0.28$ 0.33

$ 0.39 $ 0.45$45.69

Intrinsic value $48.03The investors’ assumption about the growth rates, ROE and cost of capital, mentioned above, can lead to a market

price equal to $48.20.

Problem Statement

On October 12, 2000 Home Depot, Inc. lost $33 billion of its market value because it announced that the earnings of

third and fourth quarter would be much lower than expected. The stock price declined by 28% from $49 to $35 as a

result of this announcement. But the reason is not clear that whether the decline in market price was a function of

slowing economy, a reaction to overvaluation of the stock or possible problems with the company’s strategy for

future.

If we consider the most likely case for the valuation of the stock the intrinsic value on October 12, 2000 is as follows:

Intrinsic Value on October 12, 2000EPS of 3rd Quarter= $ 0.28 Dividend of 3rd Quarter=$ 0.0308PV= $ 0.0307EPS of 4th Quarter= $ 0.25 Dividend of 4th Quarter=$ 0.0275PV= $ 0.02675

PV on Feb 1, 2001= $ 30.45PV on Oct 12, 2000= $ 29.62Intrinsic value= $ 29.68

The stock of the company was still overvalued despite the decline in market price. Throughout the year of 2000 the

stock was overvalued so the price decline in the market price was the instant reaction to the overvaluation. The

decline in price was preceded by the announcement of lower than expected earnings per share.

The slowdown of economy was one of the reasons of lower earnings growth. The rise in the interest rate caused a

decline in the demand for loan which in turn resulted in a decline in the housing turnover and home ownership. As a

result the whole home improvement industry endured earnings.

The softening of consumer demand caused the sales growth to decrease resulting in low net earnings. The decline in

net earnings can also be attributed to their aggressive expansion and market saturation as their sales had not

increased compared to their store growth endeavor. Home Depot had an average increase in sq. footage of 26% per

year for period 1986 – 2000 while average sales growth fall from an average over the same time period of 31% to

21% in 2000.

Scenario Analysis

Scenario Analysis for the Growth Schemes:

Scenario analysis is a process of analyzing possible future events by considering alternative possible outcomes

(scenarios). The analysis is designed to allow improved decision-making by allowing consideration of outcomes and

their implications. In this segment, we will consider three possible scenarios– the optimistic case, the pessimistic case

and the most likely case– for Home Depot, Inc.’s intrinsic stock value by taking their growth plans into account.

THE MOST LIKELY CASE

Our most likely scenario represents the value we derived in while estimating the intrinsic stock value of Home Depot,

Inc.’s stock in the company analysis segment. We made the following assumptions:




Multi-Stage Growth RatesYear Dividend Growth Rate (g)2001-2002 g1=16%2003-2005 g2=23%2006-2009 g3=18%2010 onwardsg4=8%

Justification for the Assumptions:

To estimate the most plausible scenario, couple of issues was considered that we believed to be most realistic. On

the premise of these issues we drew our assumption mentioned earlier. These are discussed below:

1. Risk free rate (RF) has been held at 5.8% which is equal to the yields on 10 years treasury securities because we

assume that majority of investors would invest in the securities with intermediate maturity.

2. We assumed Risk Premium (RM-RF) of 3.00%. Different studies on equity risk premium suggests that it should be

somewhere between 2.5% to 6.00% if while using the current intermediary government bond rate as the estimate of

the minimal NRFR. Here we ignored the effect of the expected inflation because we anticipate that the price of Home

Depot, Inc.’s products will rise consistently as well.

3. The retention ratio is kept constant every year because in general cases retailer companies have a high retention

rate and as a growing company with many growing schemes it is reasonable for Home Depot, Inc. to have 89%

retention rate and 11% dividend payout rate. This is the reason why the growth rate of earnings will be equal to the

dividend growth rate.

4. Though the annual growth rate of Home Depot, Inc.’s earnings over the last 10 years had averaged about 30%, in

our calculation we assumed a much more modest growth rates in the initial years (16% for the first 2 years). In view

of the fact that Home Depot, Inc. has grown to occupy a large share of the market, the company has become much

susceptible to these macroeconomic changes. The U.S. economy had experienced uninterrupted growth since 1992.

But between June 1999 and May 2000, the Federal Reserve had raised interest rates six times in an effort to

decelerate the economy. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. This is one

of the main reasons for the company’s earnings shortfall which we presume will continue for a couple of years.

5. After the initial years, our assumed growth rate will see a sharp rise to 23% as a result of benefits derived from the

growth schemes. In our most likely case, we believe, following incidents will help Home Depot, Inc. accomplish a

moderate growth rate of 23% and 18% for the years 2003-2005 and 2006-2009 respectively:

i. Increased sales from successful expansion:

Home Depot, Inc. is planning on increasing the no. of stores annually by 21-22 percent so that by the end of 2003 the

store no. will be over 1900. Moreover, redefining its industry has resulted in product sales to professional customers

in addition to do-it-yourself (D-I-Y) customers. By 1999, Home Depot, Inc. increased its market share of market for

professional customers from 4% to approximately 8.9%. This figure is expected to increase to 18% by the end of

2003.

ii. Moderate success with Buy-it-Yourself (B-I-Y) Customers:

Buy-it-Yourself (B-I-Y) Customers has created an opportunity for serving the new Market for installation services. The



iii. Average achievement with Product Categories and Store Formats:

Extension of products, services, and stores- will allow some growth with the Do it Yourself (DIY) Customers.

iv. Reasonable Success in International Growth and Internet sales:

In most possible case, an ambitious estimated outcome from these growth schemes will not be practical. Rather a

mediocre outcome is more likely.

6. We assume constant perpetual growth rate of 8.0% from the 10 th year. This is because no firm can sustain more

than the average industry growth rate in a competitive market. Since 1981 till now, the home improvement industry in

the U.S. had grown at an annual rate of about 6%, or slightly slower than the U.S. economy as a whole. In 1998 and

1999, home improvement industry growth rates were 10.4% and 7.3% respectively. However, with the expectation of

some decline in the economy, economists predict an average nominal growth in the industry.

Moreover, mediocre results in recent years and more success in the long run of International Growth and Internet

Sales growth schemes will help to sustain a decent constant perpetual growth rate.

Calculation of Home Depot, Inc.’s Intrinsic Value (the Most Likely Case):

The calculation of Home Depot, Inc.’s stock price as of February 1, 2001 required completing the following steps:

Step 1:

Calculating the Cost of Equity Capital (rs) using Security Market Line (SML):


rs= RF + β * ( RM – RF) = 9.07%

Where, RF = 5.80%

RM = 8.80%


(RM – RF)=3.00%

β HDI = 1.09

Step 2:

Determining the intrinsic value by using extended DDM model:




to get the present value. We assumed that,

Here, D/E = 11%

Where, D0 = $0.13 & EPS0 = $1.16


Period 1 2 3 4 5 6 7 8 9 10

Diluted EPS $ 1.35$ 1.56$ 1.92 $ 2.36

$ 2.90 $ 3.43$ 4.04

$ 4.77 $ 5.63$ 6.08

Dividends $ 0.15$ 0.17$ 0.21 $ 0.26

$ 0.32 $ 0.38$ 0.44

$ 0.52 $ 0.62$ 0.67

Discounted Dividends$ 0.14$ 0.14$ 0.16 $ 0.18

$ 0.21 $ 0.22$ 0.24

$ 0.26 $ 0.28$ 28.61

Our calculated value of stock was, VS = $30.45

The Optimistic Case:

While estimating our most likely value of Home Depot, Inc.’s stock we made the following assumptions:






In our Optimistic scenario, we assumed some rather bold outcomes which would occur if most factors work well in the

favor of Home Depot, Inc. On the premise of these arguments we drew the assumptions mentioned above. These are

discussed below:

1. For reasons mentioned in our most likely case, Risk free rate (RF) has been held at 5.8% which is equal to the

yields on 10 years treasury securities.

2. We assumed Risk Premium (RM-RF) of 2.50%, because studies on equity risk premium suggests that it should be

somewhere between 2.5% to 6.00% if while using the current intermediary government bond rate as the estimate of

the minimal NRFR. Here we assumed the best possible consequences.

3. In our calculation we assumed a humble growth rates in the initial years (17% for the first 2 years) which is still

slightly higher than what we presumed for our most likely case. Since Home Depot, Inc. has grown to occupy a large

share of the market, the company has become much susceptible to these macroeconomic changes. Between June

1999 and May 2000, the Federal Reserve had raised interest rates six times in an effort to decelerate the economy.

This is one of the main reasons why we assumed moderate growth rates for the first two years.

4. After the initial years, our assumed growth rate will see a sharp rise to 23% as a result of benefits derived from the

growth schemes. In our optimistic case, we expect, following events will help Home Depot, Inc. carry out a decent

growth rate of 23% and 19% for the years 2003-2005 and 2006-2009 respectively:

i. Improved sales from successful expansion:

We expect that economy will start recovering from its temporary dip by 2003 in the best set of circumstances which

will in turn increase the demand of consumer goods. Home Depot, Inc. is planning on increasing the no. of stores

annually by 21-22 percent so that by the end of 2003 the store no. will be over 1900. By 1999, Home Depot, Inc.

increased its market share of market for professional customers from 4% to approximately 8.9%. This figure is

expected to increase to 18% by the end of 2003. Extraordinary success in their expansion plans will help them

achieve the expected growth.

ii. Immense success with Professional Customers:

Serving Professional Customers provides a Large Market potential and great propensity for Repeat Business. This

scheme presents a large opportunity with high profit margins. This strategy is anticipated to influence sales the most

out of all of the initiatives.

iii. Remarkable achievement with Buy-it-Yourself (B-I-Y) Customers:

Buy-it-Yourself (B-I-Y) Customers has created an opportunity for serving the new Market for installation services. The



iv. Expected realization of target sales in Product Categories and Store Formats:

Extension of products, services, and stores- will allow continued growth with the Do it Yourself (DIY) Customers.

Because changing Product Categories would help in increasing product line, adding appliances to complement

current offerings and vertically integrate supply chain. Home Depot, Inc. plans to increase its no. of Expo design

Stores, which offers higher gross margin, to 200 within five to six years. Successful realization of these targets will

help sustain the estimated growth.

v. Excellent success in International Growth and Internet sales:

International growth initiative is believed to be very important in the next five to fifteen years as it would allow the

company to expand its realm of market presence globally. The company also intends to possess the “world’s largest

e-commerce” site in the industry through its process of developing its Internet Site.

Reasonable results in recent years will help accomplish the anticipated growth.

5. For the same reasons mentioned in the most likely situation, we assume constant perpetual growth rate of 8.0%

from the 10th year.

Calculation of Home Depot, Inc.’s Intrinsic Value (the Optimistic Case):

The calculation of Home Depot, Inc.’s stock price required the completing the same steps as in our previous scenario:

Step 1:



rs= RF + β * ( RM – RF) = 8.53%

Where, RF = 5.80%

RM = 8.30%


(RM – RF)=2.50%

β HDI = 1.09

Step 2:





to get the present value.

Here, D/E = 11%

Where, D0 = $0.13 & EPS0 = $1.16


Period 1 2 3 4 5 6 7 8 9 10Diluted EPS $ 1.35$1.56$ 1.92$ 2.36$ 2.90$3.45$ 4.11$ 4.89$ 5.82$ 6.29Dividends $ 0.15$0.17$ 0.21$ 0.26$ 0.32$0.38$ 0.45$ 0.54$ 0.64$ 0.69Discounted Dividends$ 0.14$0.15$ 0.17$ 0.19$ 0.21$0.23$ 0.26$ 0.28$ 0.31$ 63.08Our calculated value of stock as of February 1, 2001 was, VS = $65.00

The Pessimistic Case:

While estimating our most likely value of Home Depot, Inc.’s stock we made the following assumptions:






For the Pessimistic or worst-case scenario, we considered a few possibilities where things could go wrong for Home

Depot, Inc. and adversely affect their earnings and ultimately their stock value. On the assertion of these arguments

we drew the assumptions mentioned above. These are discussed below:

1. For reasons mentioned in previous cases, Risk free rate (RF) has been held at 5.8% which is equal to the yields on

10 years treasury securities.

2. Studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% if while using the

current intermediary government bond rate as the estimate of the minimal NRFR. We assumed Risk Premium (R M-

RF) of 4.50% which is much higher than both our most likely and optimistic assumptions.

3. In our calculation we assumed discreet growth rates in the initial years (16% for the first 2 years) considering the

possible downturn in the economy. Since Home Depot, Inc. has grown to occupy a large share of the market, the

company has become much susceptible to these macroeconomic changes. Between June 1999 and May 2000, the

Federal Reserve had raised interest rates six times in an effort to decelerate the economy. This is one of the main

reasons why we assumed moderate growth rates for the first two years.

4. After the initial years, our assumed growth rate will see a slight rise to 20% as a result of the growth schemes. In

our pessimistic case, we assumed unenthusiastic growth rate of 20% and 17% for the years 2003-2005 and 2006-

2009 respectively which are considerably lower than the likes of most likely and optimistic scenarios. The reasons for

such restrained assumptions are given below:

i. Continued growth in Do It Yourself (DIY) Business at a decreasing rate:

We believe that Home Depot, Inc. will continue to maintain a decent growth in their core market segment — Do It

Yourself Customers — through their multiple growth plans. But while projecting the worst case, we presume this

growth rate will gradually decrease over time.

ii. Moderate Success with Buy-it-Yourself (B-I-Y) Customers:

Home Depot, Inc. serves less than 2% of the installation service market for BIY customers, but plans to grow by 40%

each year for the next five years. In the pessimistic scenario the company can only barely achieve this target.

iii. Over-saturation of market:

If the over-saturation of certain big city-markets should happen the expected earnings of the company will be

reduced. Home Depot, Inc. and its biggest competitor, Lowe’s are both planning on opening a lot of new stores in the

next few years. In the worst case scenario, this will result in excess supply and falling of prices.

iv. Failure in achieving the target for Professional Customers and Product Categories:

Satisfying the need of different customer groups is indeed a strenuous task. It has been observed that many other

companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. In our

pessimistic scenario, Home Depot, Inc. will find it difficult to cross over with professional customers while ensuring

that the DIY customers are not disadvantaged. Moreover the company may suffer from its possible inability to

effectively handle Cross-Selling.

v. Greater sensitivity to Cyclical changes:

The professional segment and the Expo Design Center stores are going to be more sensitive to cyclical changesin

the economy.

vi. Challenges in International growth and Internet sales:

The international growth scheme presents the most complex challenges because of real estate, and logistics of the

supply chain as well as the barriers of language and cultural differences. In our pessimistic scenario, it is natural to be

more skeptical about any considerable success in this growth scheme. On the other hand internet sales may not

prove to be very helpful in near future because it is hard to set up and expensive to maintain.

5. We assume constant perpetual growth rate of 7.0% from the 10 th year because the over expansion may result into

a deterioration of performance of the company.

Calculation of Home Depot, Inc.’s Intrinsic Value (the Pessimistic Case):

The calculation of Home Depot, Inc.’s stock price required the completing the same steps as in our previous

scenarios:

Step 1:



rs= RF + β * ( RM – RF) = 10.71%

Where, RF = 5.80%

RM = 10.30%


(RM – RF)=4.50%

β HDI = 1.09

Step 2:


In our assumption of multiple growth rate models, the growth rate rises sharply after the first two years then gradually



to get the present value.

Here, D/E = 11%

Where, D0 = $0.13 & EPS0 = $1.16


Period 1 2 3 4 5 6 7 8 9 10Diluted EPS $ 1.35$1.56$ 1.87$ 2.25$ 2.70$3.15$ 3.69$ 4.32$ 5.05$ 5.46Dividends $ 0.15$0.17$ 0.21$ 0.25$ 0.30$0.35$ 0.41$ 0.47$ 0.56$ 0.59Discounted Dividends$ 0.13$0.14$ 0.15$ 0.16$ 0.18$0.19$ 0.20$ 0.21$ 0.22$ 6.43Our calculated value of stock on February 1, 2001 was, VS = $8.01

Recommendation & Policy Implication:

Home Depot is the largest retailer of home improvement products and third largest retailer of any sort in United

States. Home Depot had competencies that very few other retailers had and was one of the most successful retailers

in American history. The company has been able to sustain extraordinary financial and operating performance over

the years. The annual growth rate of Home Depot, Inc.’s earnings over the last 10 years had averaged about

30%.The company’s stock price had also risen dramatically. Between the fall of 1981 & End of 1999, stock price had

risen at a compound annual rate of 52%.

However, after nearly two decades of spectacular performance, Home Depot reported a disappointing performance in

the year 2000. On October 12, 2000, Home Depot, Inc. announced that earnings in the 3 rdand 4th quarters of 2000

would be much lower. This announcement had an adverse impact on their stock’s market price. The slowing

economy in 2000 combined with Home Depot’s aggressive expansion efforts was thought to be the reason for Home

Depot’s poor financial performance.

In this final section of our report, we try to present some indications to Home Depot, Inc. as to what should be their

ideal courses of action. We believe, by focusing on the following suggestions they will be able to achieve a desirable

growth described in our valuation segment of company analysis.

1. Focus on Quality:

Home Depot, Inc. should be more concerned with the quality of their products and services rather than pursuing a far-

fetched expansion policy because quality of their customer service is one of their core competencies. By focusing on

quality Home Depot, Inc. would be able to ensure continued growth in their main target segment of DIY customers as

well as achieve considerable success in professional segment. Moreover, to exploit the opportunities presented by

BIY customer segment, it is vital to focus on greater service quality.

2. Implement “Customer Groups” and “Product Category” Plans with Much Prudence:

Fulfilling the needs of different customer groups is a demanding task. Home Depot, Inc. must ensure that DIY

customers are not disadvantaged by their “pro-initiative”. It has been observed that many other companies are doing

better than Home Depot, Inc. in terms of product mix and focused customer strategy. Home Depot, Inc. must

overcome their limitations and try to achieve comparative advantage in the professional market in terms of broader

and deeper inventory, more knowledgeable sales help, and reliable delivery.

Home Depot, Inc. should also work hard towards realizing their goal of being the no. 1 in the retail market for major

appliances. To be successful in this feat the Home Depot, Inc. must be able to properly integrate different products

within a given organizational structure to contend against possible competition.

3. Slow Down with “Store Formats” Schemes:

Home Depot, Inc. plans to increase its no. of Expo design Stores, which involves fewer inventories, higher gross

margin, higher payroll expense and a greater sensitivity to cyclical changes in discretionary income, to 200 within five

to six years. We feel that Home Depot, Inc. should go slow with this strategy because it doesn’t fit well with their

current strategy & business plan and success from this scheme is much doubtful.

4. Saturate North American Market:

Instead of over saturating the big city markets like Atlanta, Georgia, and Dallas, Home Depot, Inc. should look at the

bigger picture and increase its no. of stores in cities where competition has not heated up yet and focus on the whole

U.S. market.

5. Revise the “International Growth” plans:

Since the international growth scheme is the riskiest of all plans and presents the most complex challenges because

of real estate, and logistics of the supply chain as well as the barriers of language and cultural differences, Home

Depot, Inc. should reassess this strategy. Home Depot, Inc. should focus on covering the North American market first

and then consider joint venture methods for entering the global market.

6. Increase the Debt-Equity Ratio:

Home Depot, Inc. can opt to raise their debt to enjoy increased Return on Equity (ROE). However, they must ensure

that the interest to be paid on these debts do not exceed their Return on Assets. Our calculation validates this

recommendation:

On, January, 2001, Home Depot, Inc.’s financial statements contained the following data:

a. Profit Margin = 5.84%

b. Asset Turnover = 2.25

c. Equity Multiplier = Total Assets/Total Equity

= 20663.65/14929.49

= 1.38

Return on equity (%) = a*b*c

= 18.20%

Debt/Equity Ratio = Equity Multiplier -1

=0.38

Now if we set, Debt/Equity Ratio = 0.45, the Equity Multiplier will be,

d. Equity Multiplier = 0.45+1 = 1.45

So, the new ROE = a*b*d = 19.07%

In conclusion, we can assert that, by pursuing our suggested courses of action, Home Depot, Inc. can expect to have

an intrinsic stock value that roughly amounts to $30.45 on February 1, 2001.

Conclusion

A firm’s ultimate goal is to maximize the owner’s i.e. the shareholders’ wealth. In pursuing the firm’s goal of

maximizing the stock price, the financial manager must carefully consider the balance of return and risk associated

with each proposal and must undertake only those that create value for owners. By following our suggested course of

action Home Depot, Inc. can achieve this goal. On the other hand prudent investors must have a comprehensive

understanding about the intrinsic value of the firms’ stock they want to invest in and make their investment decision

based on that. Home Depot, Inc. stocks had a lower intrinsic value at October 2000 than its market value. The

investors should be cautious about investing in an overvalued stock. The financial statements and information on

firm’s growth initiatives are periodically published, analyzing which the investors can get an idea of the intrinsic value

of the stock to make the correct decision.

Documents

HOme Depot