Home Depot: Breaking Down the 2000-2005 US Housing Boom Experience

After some very strong YTD earnings from some of my favourite housing related companies , US housing was foremost in my mind and I got curious about what these stocks were like in the 2000-2005 US housing boom. 

These were the returns on some top notch housing companies from investing $1 into each one on 2001/03/01 (i.e. after FY2000 earnings and 2001 guidance #s were out) until the end of 2005:

• D.R. Horton 45% CAGR / $1 → $6

• NVR 39% CAGR / $1 → $4.86

• Sherwin Williams 16% CAGR / $1 → $2.01

• Pool Corp 32% CAGR / $1 → $3.83

• Lowe’s 20% CAGR / $1 → $2.45

• Home Depot 0% CAGR / $1 → $1

• $6 turns into ~$20 in 4.75 yrs.

As expected, the housing basket overall had extremely good returns. But there’s a clear outlier here. I was pretty intrigued so I spent the last week digging into what happened with HD during that period. It seemed pretty remarkable. The biggest housing boom (bubble) of all time and massive cash-out refi driven home remodeling spending that dwarfs anything since and...a 0% CAGR on HD.

HD was one of the great high fliers of the 90s. From 1990-1999, HD stock had a 46% CAGR, turning $1 into $43, as sales increased 10x from 3.8B to 38B, a 26% CAGR, and earnings increased from $160M to $2.3B, a 30% CAGR. (Jaw drop) 

It was the dominant player in its industry. (Lowe’s lagged behind substantially in quality of locations, much lower sales per square foot and much lower ROICs/ROIICs)

And the company wasn’t close to slowing down. From 1997-2000, EPS more than doubled, growing at a 28%/yr rate.

As an investor in early 2001, you’d have found a company with a consistently high ROIIC, and a long future runway of growing EPS at 15%-20% at the least. You’d have found a stock that was already down from it’s peak tech/growth bubble high of $65 and by Q1-2001 was trading at only $40. Only ~31x expected 2001 EPS. If you were a patient growth bro, the stock was at only 25x-26x 2002 consensus EPS. Assuming continued 20% EPS growth for the next half decade (which would’ve been a correct forecast) HD seemed like a steal. How the heck would that not work?? 

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So…why did it not work?

The themes were in fact pretty similar to what I learned in studying McDonald’s during that same period. 

HD went from 145 stores in 1990 to 1130 stores by 2000. Even starting 2000, the mood was ebullient and HD traded at ~40x-50x NTM EPS estimates. HD was the undisputed wide-moat leader of the growing big box home improvement retail industry. 

But there was evidence that similar to McDonald’s in the same exact time period, the marginal economics of the business were getting worse. Still good but incrementally worse. 

A 46% stock CAGR for a decade is likely to incentivize a management team to (over?) invest and is likely to attract competition as well. So both Lowe’s and Home Depot were opening stores incredibly fast. HD alone was opening 1 new store less than every 2 days.  The company was in go-go growth mode. 9 separate regional managers basically ran their own fiefdoms, bought their own inventory, had their own IT systems etc. There was actually no way for the CEO to send a company wide email! Like MCD, HD and LOW were opening stores faster than they could manage to operate them properly.

And these new stores clearly had worse economics. 

Sales per square foot which had climbed steadily from $300 to $425 from 1989 to 1999 were now inflecting down. Sales/sq foot fell to $415 in 2000 and $388 in 2001. 

The marginal store was either in a slightly worse location or cannibalizing the existing store base more and more. 

By the end of 2000, the economy was a little slower. The wage growth of the 90s boom was ending. The euphoric participation in the stock market was coming to an end as well and multiples on great companies in general were coming down. 

HD had 7% same store sales growth in 97, 7% in 98, and 10% in 99. 2000 was an anemic 4% and 2001 had 0% SSSG (negative for the first three quarters of ‘01 and a big post 9/11 rebound for Q4-2001).

The last hurrah was the post 9/11 (i.e. Q4-2001 to H1-2002) “cocooning boom” as it was called then (yes that is real). 9/11 made folks feel very vulnerable. An out-of-nowhere massive catastrophe like that on home soil puts life into perspective. American consumers for the most part responded by “cocooning” with their families and spending liberally on their homes, the one place where they felt safe. They also were not comfortable travelling, so the saved extra disposable income flew into home furnishings, remodels/renos, and consumer electronics. (Not surprisingly, even sales of guns & ammo took off). 

From the week after Sep 11 to March 2002, HD was up 44%. Lowe’s was up 69%. Pier 1 Imports was up 150%. Even WMT and Target rose 33% and 50% respectively. 

Of course, by the second half of 2002, that spend was normalizing again and now analysts started talking about “tough comps” for the rest of the year. 

As the comps rolled in, in 2002 HD had probably it’s first negative SSS year in probably ever. In addition to tough comps, HD was telling investors it was cannibalizing 25%+ of its store base (and it had to do it, otherwise Lowe’s would have opened there). Thus, sales per square foot continued declining and would bottom at $370 (GFC excluded). The end of the growth runway was also starting to appear. A dim light far away, but now visible. Bernstein (sell-side research firm) was telling clients that at the rate of store openings at the time, the big box home improvement store market would be mostly saturated by 2004/2005. 

And so, just like with McDonald’s, 2002 was the annus horribilis. Investors went from imagining an ever accumulating snowball rolling downhill to a tedious Sisyphus-like climb up against competition from Lowe’s, a slowing economy, store saturation and very weak NTM and N24M comps along with a publick that no longer cared about your quality stocks and was happy to throw the baby out with the bathwater. The stock was the worst performer in the Dow in 02, falling 53% that year, to $21.

$21 was indeed the bottom. The company still had a bright future, and earnings continued to grow at a good clip to 2005. The housing boom helped, but the store base also doubled from 2000 to 2005 and ROIIC remained healthy. Earnings were up 20%/yr from 00 to 05. HD didn’t wither and die! Not even close. (In fact, you’d still have earned a solid 13% compound return on HD if you’d held from Q1-2001 to today). 

But the market discounts the future. So the new 12x-15x P/E multiple ended up being pretty sticky, despite underlying growing earnings over that immediate period. Sticky enough to stick for another 7-8 years after 2005. 

Say I even saw the housing/cash-out refi remodeling boom coming and loaded up on the highest quality beneficiary. I would’ve broke even. The person that bought the lowly homebuilders DHI/NVR would have $5 to my $1. (And ~$30 today to my $12). Even the investor in the cheaper, lower quality #2 Lowe’s would have $2.45 at the end of 2005 and $18 today.

The P/E multiple gap between HD and Lowe’s got fully closed in 2002, more because HD fell down to LOW’s level than the reverse. (LOW during the 2000 peak traded at a 6x-10x discount to HD and was at 22x 2001 and 16x 2002 EPS as of our Q1-2001 starting point)

“People too often buy the lower quality company just because it’s cheaper when they should just buy the quality leader.”

“Well, did it work for those people?”

“No. It never does. These people delude themselves into thinking it might but…

But it might work for us”

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The trouble with high multiples (‘high’ is an intentionally ambiguous term to be sure) is you have to get two things right. You have to obviously have a relatively high level of confidence in continued growth over the next 4-5 years, but you also have to have a view on the perception of growth for the next 4-5 years after that. A high P/E is like convexity in long duration bonds. (I almost failed the fixed income section of my CFA exams 3x so I hope this is actually correct lol - I think you get my point). The going-in earnings yield is quite low so future growth and future expectations of growth are critical - modest changes in future expected growth paths can move the stock a lot. 

Everyone should read this incredible post by the tremendous @Jesse_Livermore:

https://www.philosophicaleconomics.com/2014/03/wmt/

It had a huge impact on me when I read it in 2014. You could’ve paid a 600x PE for Wal-Mart in late 1974 and you’d have matched the market return. (which pretty good in its own right)

But this is where I have to admit I may be too dumb or too ignorant an analyst. It’s hard to force this math. I have to wait until the lightbulb goes on in my head. That special moment where you really, truly feel so strongly about the inevitability of a company. The best articulation I’ve seen in this era has been Sleep/Zak talking about Amazon (interestingly, very similar case to Wal-Mart). But I’m not there yet. I’ll be happy if it happens 1x or 2x or in my career. For the most part, there are great companies with good runways to be sure, but none where I see no competitive risk, no valuation risk, no management risk, no macro risk, and just rapidly increasing and increasing gobs of earnings for a decade plus into the future. 

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I’ve shared these figures before on twitter of how well housing stocks have done over the last decade, probably matching, if not beating QQQ:

• NVR: 24% CAGR

• DHI: 27% CAGR

• BLDR: 36% CAGR

• SHW: 27% CAGR

• Being a Canadian: 70% CAGR (Being a Vancouverite: 100% CAGR)

• POOL: 34% CAGR

• SITE (since IPO): 35% CAGR

• LGIH (since IPO): 39% CAGR

But to be honest, in 2011/2012, you’d be looking back at huge amounts of excess, overbuilt housing stock, still very high levels of consumer debt (which at ‘normal’ interest rates would eat up any future consumer disposable income growth - an adjustment that was pretty natural to make back then) and an almost traumatic level of capital destruction in US real estate and related sectors during the GFC.

Investing can be fucking hard.

And today? I think about charts like this: 

The US was regularly installing 100k+ new residential swimming pools for ~15 years and is just now going to cross that 100K number in 2021. 

We all read the reports of rampant NIMBYism, a 1.5M deficit of housing stock, the coming favourable demographic boom of first time homebuyers etc. 

For those reasons, I was a medium housing bull in the 2015-2020 period but why wasn’t I super bullish? Sometimes, a market has been in the gutter for so long that it starts to feel normal and normal feels unsustainable. I wouldn’t really have needed to figure out anything else and I’d have an insane record. Why do I only think of this stuff when everyone else also starts thumping the table (which has mostly been during this massive covid reno/homebuying resurgence)? 

Sure, sentiment often just follows the data, but both can still change in an instant. Just as recent as late 18/early 19 as Powell was raising, housing got pretty damn cheap. You could’ve added to NVR at like 10x-11x NTM P/Es. As I said, I was bullish enough, but boy if you just got this one thing right over the last decade, you’d have virtually the best track record of the decade.

How much of even this feeling, of being a little slower than I should be, of being a little less confident than I should be, is just due to trends being on 3x speed due to COVID? 

Investing, in the real world, and for my brain at least, remains fraught with uncertainties and risks. Constrained by my own lack of enough knowledge, time, and IQ. And frankly a personal abundance of faulty thinking and ignorance. Nonetheless, you keep working your ass off, and wait for the insights.