Sources: Home Depot and Lowe’s

Home Depot & Lowe’s outperformed the S&P500 from 1978 to 1982 and during a period of high, double-digit inflation

Inflation and the fear of persistent inflation generate volatility in financial markets. In 1979, 1980 and 1981, the United States experienced double-digit inflation, as measured by the consumer price index [CPI]and Home Depot (NYSE:HD) and Lowe’s (NYSE: LOW) outperformed the S&P500 during this period [see below chart, developed using my Fidelity account – January 2, 1978 through December 31, 1982]:

With the new paradigm shift of stay-at-home and post-Covid, there is every reason to believe that HD and LOW will do just as well as the US enters a new period of high inflation.

A paradigm shift from unpaid travel to home office

Covid closures have forced school closures and work disruptions over a long period of time. This encouraged many people to focus on home improvement projects as they had to convert a room into a home office and had to reconsider the health risks associated with face-to-face socializing. While it is reasonable to assume that a significant portion of the increased cash flow from operations enjoyed by Home Depot and Lowe’s benefited from these lockdowns and reduced socializing, it is not reasonable to believe that easing pressures or higher inflation will result in reduced cash flow from operations. The graph above illustrates this point, where it includes 1979, 1980 and 1981, represented 3 consecutive years with double-digit inflation.

Graph of the most recent increases in HD and low price per share

Below is the 2 year chart for HD and LOW, created using my Fidelity account on Saturday January 15, 2022. The chart covers the 24 month or 2 calendar year period from January 2, 2020 to December 31, 2021 . [the Covid period]. Note that Lowe’s is a bit more volatile than Home Depot [the Beta measure, using my TDAmeritrade account, was 1.0 for Home Depot and 1.3 for Lowe’s]:

Below is a slightly revised 2-year chart for HD and LOW, created using my Fidelity account on Saturday, January 15, 2022. I am providing this chart for comparison with the above, as it includes a very recent decline. [see the orange arrows and box in the below graphic] in price per share [PPS] for both titles:

There is no reason to believe that the work-from-home trend will be completely reversed. In fact, there is a tendency to work from home preferences reported, frequently, on both business news and popular news outlets.

Operating cash flow doubled in 4 years for Home Depot and Lowe’s

HD and LOW both benefited from a doubling of positive cash flow from operations over a 4 year period. This is illustrated in the data below, captured from my TDAmeritrade account on January 15, 2022, for HD:

Note that cash flow from operations has gone from $9.7 million to $18.8 million in 4 years [see above, where measures are in millions of dollars].

The data below was captured from my TDAmeritrade account on January 15, 2022, for LOW:

Note that cash flow from operations went from $5.6 million to $11.0 million in 4 years [see above, where measures are in millions of dollars].

Will inflation and rising mortgage rates be a headwind for Home Depot and Lowe’s?

I wanted to get an idea of ​​the impact of rising interest rates and mortgage rates on Home Depot and Lowe’s. Perhaps higher inflation and higher mortgage rates will reduce the demand for homeownership and home improvement tools and materials?

I looked at some monthly metrics from January 1985 to December 2021. I also isolated this methodology by looking separately at the 2-year or 24-month period from January 2020 to December 2021.

This is only a very basic review of the period after 1979, 1980 and 1981, where we had 3 consecutive years of double digit inflation as measured by the consumer price index. The 1985 forecasts were selected to exclude this period of high inflation.

Similarly, the 2 year or 24 month period from January 2020 to December 2021 is what I might call “the Covid period”, where I am interested in getting descriptive statistics and looking at a graph to see exactly what kind of l impact this period had on the SPA for both Home Depot and Lowe’s.

Below are some charts for The Home Depot for the period January 1985 to December 2021:

I used data from Yahoo! Funding for the Adjusted Closing Inventory PPS for The Home Depot and this site for 30 year mortgage rates. 30-year mortgage rates remain historically low, so I’m not sure an additional 1% or 2% increase in mortgage rates for 2022 would have a significant negative impact on home purchases and/or improvement projects requiring the purchase of tools or construction. materials.

The correlation is inverse, intuitively appealing, and with a single independent variable, higher (lower) mortgage rates explain about 43.5% of Home Depot’s stock PPS increase. This correlation may or may not be causal – it’s up to you – however, I find it intuitively appealing to believe that higher mortgage interest rates make it less likely for the average person to qualify for a 30-year mortgage and home ownership, while the ‘anticipation’ of higher mortgage rates could incentivize renters to buy.

Below are some charts for The Home Depot for the period January 2020 through December 2021:

Again, I used data from Yahoo! Funding for the Adjusted Closing Inventory PPS for The Home Depot and this site for 30 year mortgage rates. Also, again, 30-year mortgage rates remain historically low, so I’m not sure that an additional 1% or 2% increase in mortgage rates for 2022 would have a significant negative impact on the tools or materials of home renovation.

The correlation is, again, inverse, remains intuitively attractive, and with a single independent variable, higher (lower) mortgage rates only explain about 9.8% of the stock PPS increase. Home Depot. Again, this correlation may or may not be causal.

The decrease in correlation and explanatory power for the period from 1985 to 2021 and from 43.5% to 9.8% for what I have chosen to call “the Covid period” [2020 & 2021] may or may not be causally related, but, having lived through the period of double-digit inflation from 1979 to 1981 and given the concerns Americans seem to have about current and near-term future levels of inflation , I chose to focus on these measures.

Year-to-date price per share changes for Home Depot and Lowe’s and versus the S&P500

The table below provides a 2022 year to date [YTD] graph and comparison for the S&P500, HD and LOW:

HD and LOW are underperforming, YTD, against the S&P500. On top of any stock PPS appreciation one might expect, HD is offering an annual dividend of $6.60 per share for a yield of 1.85% [source is TDAmeritrade] and LOW offers an annual dividend of $3.20 per share for a yield of 1.4% [source is TDAmeritrade]. Both stocks have a 10 out of 10 ranking and a “Strong Buy” rating on TDAmeritrade.

Limits

Parts of this article use correlation, and it was not my intention to design an exhaustive predictive model. I like to run descriptive statistics on some of my stock picks. It reduces the subjective level of the decision-making process. There are still many subjective variables that I have not addressed.

For example, I cannot quantify the offset of higher mortgage interest rates against the reduction in costs associated with housekeeping or the reduction or elimination of unprofitable travel and related costs. Travel time is not compensated. Additional car, parking and related costs are reduced and/or eliminated, as is unpaid time consumed by an employee dressing “for the office”. In my case, I would prefer to buy a bigger and more expensive house to provide the home office and avoid the costs associated with “going to the office” every day of the week, because this suggests the article.

Summary

I like both Home Depot and Lowe’s as long term buy and hold stocks. Covid has ‘forced’ many to stay home, and caused a paradigm shift, as some employers have to pay bonuses, just to get employees back to the office or bring in new hires. More time spent at home will likely warrant further renovations, while rising inflation rates and nominal mortgage interest rates could prompt some to avoid rents and buy a home.

A review of the last period of high/double-digit inflation—1979, 1980, and 1981—suggests that higher mortgage rates and higher inflation will not negatively impact improvement trends. housing and I think Home Depot and Lowe’s and their stock prices will continue to do relatively well as Americans adjust to higher rates of inflation in the post-Covid years.