Motley Fool: Home Depot offers growth opportunity

Yes, shares of The Home Depot have been a bit depressed due to concerns over the strength of the housing market’s recovery. But there’s a lot to like about the world’s largest home improvement retailer, with more than 2,200 retail stores in North America.

Its competitive advantages include its size, geographical presence, brand recognition and superior negotiating power with suppliers. With price competitiveness a central industry factor, The Home Depot can keep costs down by spreading fixed costs over massive sales volume. It has also built a solid relationship with contractors over the years, a key clientele in the home improvement business.

The Home Depot has implemented a series of strategies to increase efficiency and streamline operations. The combination of growing sales and improving profit margin has been notoriously profitable for The Home Depot and its shareholders during the last several years. In its last quarter, revenue grew 3 percent year over year to $20 billion, with diluted earnings per share rising 20.5 percent. Management expects earnings per share to grow by a big 17.6 percent during fiscal 2014.

The Home Depot has been returning billions of dollars to shareholders via aggressive stock repurchases, and its dividend yield was recently 2.3 percent. With its P/E ratio near 20, The Home Depot offers a good buying opportunity for long-term investors. (The Motley Fool’s newsletters have recommended The Home Depot.)

Ask the Fool

Q: What’s “the accrual method”? — H.W., Hattiesburg, Mississippi

A: It’s an important accounting concept, because with the accrual accounting system, the “revenue” (sales) on a company’s income statement may not have actually been received by the company.

Revenue doesn’t necessarily represent the receipt of cash in a sale. Many companies are required to book sales when goods are shipped or when services are rendered. But others can record sales when cash is received, or in increments as long-term contracts proceed through stages of completion.

Imagine the Free Range Onion Company (ticker: BULBZ). With the accrual method, if it has shipped off a thousand crates of onions but hasn’t yet been paid for them, those sales still appear on the income statement. The checks in the mail are reported as “accounts receivable” on the balance sheet. It’s a red flag when receivables are growing faster than revenue.

Q: What’s a “reverse merger”? — E.P., Norwich, Connecticut

A: A reverse merger is also referred to as a reverse takeover or a reverse IPO (initial public offering). It’s a way that some private companies go public, bypassing the usual IPO process that can be lengthy and costly. It often involves a smaller company acquiring a larger one that’s listed on the stock market, accumulating so many shares that it becomes a listed company, too.

It isn’t such an obscure practice, either. Companies such as Occidental Petroleum, Turner Broadcasting, Texas Instruments and Jamba Juice all became public companies through reverse mergers. There’s a sometimes problematic side to it, too, such as when some foreign companies that wouldn’t otherwise qualify to be listed on American exchanges execute reverse mergers with publicly traded U.S.-based shell companies. Regulators are cracking down on that.

My dumbest investment

I greedily read a mailed ad that promised huge earnings for an oil-and-gas penny-stock company. Later, I tearfully read my in-the-red investment report. The author of that brochure smiled all the way to the bank, thinking, “There’s one born every minute.” I qualify as one born, so now I really pay attention to financial advice! — P.D., Weymouth, Massachusetts

The Fool responds: Naive investors fall for hyped penny stocks all the time, and it hardly ever ends well. The company in question was trading around $0.04 per share when you wrote to us, which can entice investors thrilled at the idea of owning 25,000 shares for just $1,000. Factor in a hypester’s empty, self-serving declaration that the stock will double or triple soon, and it can be almost irresistible.

But even stocks that seem like they have nowhere to go but up can still go down. That stock was recently trading for less than $0.02 per share. It’s best to avoid penny stocks entirely, but if you must consider one, look for growing revenue, little or manageable debt, profits instead of losses, competitive strengths and audited financial statements.