Personal Finance

A Closer Look at Home Depot's $2 Billion Stock Buyback Boost

A customer holds a power drill in a home improvement store.

Home Depot (NYSE: HD) has made a habit out of edging past major operating and financial targets over the last few years, including core metrics like sales growth, profitability, and earnings. But there's arguably no forecast that the management team more consistently -- and dramatically -- overshoots than its goal for stock buyback spending.

In just the latest example of this trend at work, the home improvement retailer recently said it plans to buy $6 billion of its stock in 2018 rather than the $4 billion it had predicted in late May.

A customer holds a power drill in a home improvement store.

Image source: Getty Images.

The pattern and the payoff

The move fits a pattern that long-term shareholders have seen over and over again. The retailer entered the 2016 fiscal year predicting $5 billion of repurchase spending but ended up directing $7 billion , equating to roughly 90% of earnings, to that capital return channel.

Executives forecast $5 billion of buybacks last year, too, but the final number landed at $8 billion . Assuming Home Depot doesn't lift its goal again this year, the company will have spent $7 billion more than it originally projected on stock buybacks in just the last three fiscal years.

There are a few benefits for shareholders tied to this aggressive spending. The most direct is that it helps keep per-share earnings growing at a faster clip than net income -- thanks to the dramatic decrease in the number of shares outstanding. In fact, Home Depot's share base has dropped by nearly 20% in the last five years, which helped share profits jump 18% in 2016 while net income rose by only 13.5%. A similar story played out last year, with per share profits up 13% as net income expanded by 8.5%.

But executives are more interested in using stock repurchase spending to lift the company's core efficiency metric, return on invested capital . By directing cash toward lowering the share count, even with help from more debt, Home Depot has pushed this rate up to 35% of sales -- far higher than its best result before the housing market crisis hit just over a decade ago.

HD Return on Invested Capital (TTM) data by YCharts

The bigger return picture

Home Depot is an aggressive dividend payer, which is its other main channel for direct shareholder returns. It targets a payout of 55% of annual earnings, compared to just 35% for rival Lowe's .

After that threshold is met, executives have chosen to direct most excess cash toward buybacks. And while the business requires plenty of capital investments on things like store remodels and a broader e-commerce infrastructure, its store footprint is steady and so those requirements aren't especially taxing. Thus, any additional resources that management can secure tend to go mostly toward stock repurchases.

Low interest rates in the prior few fiscal years meant that debt was cheap for Home Depot to acquire, and that played the biggest role in lifting its stock buyback goal. Earnings spiked last year, too, thanks to the happy combination of surprisingly strong sales growth and extra demand from hurricane rebuilding efforts.

Those particular trends might not repeat this year. But, with half of fiscal 2018 behind it, Home Depot appears poised to log healthy customer traffic growth even as its tax liabilities plunge. Management is responding to that brightening outlook the same way it has in each of the last few years: by allocating more cash toward reducing the retailer's outstanding share count.

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Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool has the following options: short September 2018 $180 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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