Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.
Home Depot (HD)
Jim: Up first today, Mike, is the Atlanta-based retailer that revolutionized the do-it-yourself hardware industry with its enormous stores, huge selection and low prices.
Mike: Yeah, Home Depot is the epitome of a "category killer," meaning it's so big and successful that it's been knocking much of the competition out of the box.
Jim: True. Founded in 1978, Home Depot now has 720 stores and expects to have more than 1,300 within the next couple of years. And as it's grown, many other chains have dropped from sight.
Mike: One reason is that Home Depots are more than just hardware stores on steroids. They provide the kind of service you'd expect to get at your small neighborhood hardware store. The company actually staffs its stores with professional plumbers, builders and the like.
Jim: Though I must say that I've often found Home Depot's service less than thrilling, especially on weekends. Sometimes I feel like a rat in a maze in those giant stores, and the checkout lines tend to get very long.
Mike: Right, you always run the risk of getting into a line behind some local contractor who's buying a forklift worth of drywall.
Jim: There's no getting around HD's success, though. A decade ago its annual sales were $2 billion; now they're $24 billion. Its stock is up 75% in just the past 12 months and now trades in the mid-50s.
Mike: It wasn't always so.
Jim: No, Home Depot's stock went flat in the mid-1990s, mainly because Wall Street got worried that the chain wouldn't be able to sustain its sizzling growth.
Mike: That's less of a worry now. And HD's latest move sets it up to be a category killer in yet another category.
Jim: Which is?
Mike: The small hardware store. Home Depot is looking at opening smaller outlets in storefront locations, the idea being that you'll get the same personal touch that you would at the corner hardware store where you now buy a bag of brads.
Jim: It makes sense. The vast majority of hardware stores are mom-and-pop outlets.
Mike: And Home Depot already has wiped out many of the national or regional building-supply chains. In fact, on a national basis it really has only one competitor left.
Jim: Lowe's Cos.?
Mike: Correct. And in a bid to at least stay close to Home Depot, Lowe's is buying one of the few remaining chains, Eagle Hardware.
Jim: All you have to do is look around Southern California and you can see what's happened. Home Depot's only chain rivals are Orchard Supply Hardware, owned by Sears, Roebuck & Co., and the ailing HomeBase Inc. Home Depot also has benefited from the resurgent housing market. You've got low inflation and low interest rates, which are helping spur housing sales and consumer spending.
Mike: Home Depot also is trying to sell us on the notion that if housing sales turn down, it will still do fine because people will be upgrading the houses they're already in.
Jim: So here's a stock that's been surging and now carries a very rich price-to-earnings multiple of 53. In fact, I'd venture to say that's one reason Home Depot is one of the biggest targets of short sellers on the Big Board. As of Jan. 15, some 32 million shares had been sold short and not yet repurchased, though that's still only 2% of its total shares outstanding.
Mike: Where I come from, that's a bullish argument for this stock, because those shares will have to be repurchased eventually, and that will send the price higher.
Jim: Well, I think the shorts are wrong on this stock in any case, and it's a buy.
Mike: Gee, I was worried there for a minute. Usually when you start talking about rich multiples, you're lookin' to bail out. I'm glad to hear you agree with me.
Jim: Home Depot deserves that rich price. Look, despite its huge expansion to date, it still has less than 20% of the U.S. do-it-yourself hardware market. That means there's tremendous growth potential left. Also, the economic and housing conditions that have helped Home Depot aren't likely to change much in the next 12 to 18 months.
Mike: There are a couple of minor caveats with this company. One is its increasing size. You know, the legendary founders of Home Depot--CEO Arthur Blank and former CEO Bernie Marcus--took pride in visiting every new Home Depot they opened. But now the chain is so big they can't do that anymore.
Jim: Which raises the question of whether they've got the people in place to make sure their edicts are carried out.
Mike: That's right. On the other hand, this is a company that's got terrific momentum and a great track record. So even with its rich valuation, this stock has a ways to go.
Western Digital (WDC)
Mike: Now we move from a stock that's pretty easy to value to one that, I think, is a lot thornier, because it's in a much tougher business. I'm talking about Western Digital, the Irvine-based maker of data-storage disk drives for personal and higher-end computers.