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Investing: Home Depot's returns rely on customers, efficiency

A look at Home Depot's prospects. Also: Would Mutual Quest fund fit into a basic investor portfolio?

July 17, 2011|By Andrew Leckey

Question: I am a customer and shareholder in Home Depot Inc. Despite the economy, are there good prospects ahead?

Answer: The results of the world's largest home-improvement retailer are tied to consumers' willingness to buy for their homes and to the company's operating efficiency.

The question for stock investors is whether both factors will be strong enough to provide robust returns.

Despite a sales drop in its fiscal first quarter, which ended May 1, net income rose 12% to $812 million as costs fell, profit margins went up and the company bought back its shares. Over the last three years the company updated its distribution network and the technology tools that control store inventory, pricing and sales.

Home Depot shares are up 2.4% this year so far. In good financial shape, the retailer announced in June that it would pay a cash dividend for a 97th consecutive quarter.

Home Depot operated 2,245 stores at the end of the first quarter, with almost 2,000 of those in the U.S.

The maturity of the U.S. market and price competition with Lowe's Cos. may constrain U.S. sales. And overseas markets, despite their growth potential, can be unpredictable and volatile. Home Depot closed a store in China in the first quarter, and news reports have documented the company's difficulties in that country.

The consensus analyst recommendation on Home Depot stock is "buy," says Thomson Reuters, consisting of 10 "strong buys," eight "buys," 11 "holds" and one "sell."

The economy and housing show signs of stability, with spending on small projects rising, said Zacks Investment Research, which has a long-term neutral recommendation on the stock. It added this caution: "We believe that spending on big remodeling projects will likely remain under pressure in the near term."

Mutual Quest fund looks for bargains

Question: Would the Mutual Quest fund fit into a basic investor portfolio?

Answer: It depends on how you feel about beaten-up stocks and distressed debt securities.

That's the forte of this fund, which seeks out bargains among companies of various sizes that it deems deeply undervalued.

While this involves some degree of risk-taking, the volatility is controlled and holdings don't have far to fall in price. The fund often holds a large cash position — currently 11% of assets — until it finds investments that pass its tests.

The $5.3-billion Mutual Quest "A" (symbol: TEQIX) has returned 13.6% over the last 12 months to rank in the lowest 10% of world stock funds. Its three-year annualized return of 5% placed it in the upper one-third of its peers.

"If you define your core investments as U.S. large-caps or even multinational stocks, this wouldn't be considered a core holding," said Bridget Hughes, mutual fund analyst with Morningstar Inc.

Lead manager Shawn Tumulty and his associates consider discounted cash flow and the value of each of a company's parts to determine value. Nearly half of assets are in the U.S. The fund recently owned 86 stocks and 14 bonds. Consumer goods and financial services each represented about 20% of the portfolio, with other concentrations in healthcare, communication services and utilities.

Top stock holdings were recently Telefonica, British American Tobacco, GDF Suez, Royal Dutch Shell, Time Warner Cable Inc. "A," A.P. Moller-Maersk, Altria Group Inc., Vertis Inc., United Health Group Inc. and Imperial Tobacco Group.

The fund imposes a 5.75% sales charge on purchases of fund shares and requires a $1,000 minimum initial investment. It has an annual expense ratio of 1.13%.

Andrew Leckey answers questions only through the column. Write to him at yourmoney@tribune.com.

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