Could buying Home Depot stock today set you up for life?

Over the past several decades, Home Depot (HD -0.02%) has grown into one of the world’s largest retailers while generating life-changing returns on investment for shareholders. Home Depot stock has turned a one-time investment of $100 at the IPO into more than $3.6 million today.

The company’s secret? It is a well-run company in a growing housing market. Home Depot has broadly allocated its financial resources over the years, which combined with steady sales growth make long-term investors very wealthy. The million-dollar question is whether Home Depot can still do the same for people who buy the stock today.

I crunched some numbers to find out and sketched the answer.

A best-in-class retail business in a massive market

Today, Home Depot is the world’s largest home improvement retailer with approximately 2,300 stores throughout North America. The company generates over $154 billion in annual sales. Its sheer size and scale is a competitive advantage because it can buy and sell products more cheaply and deliver them more quickly than its smaller competitors. Plus, Home Depot’s wide footprint means most consumers live within a reasonable distance of a store.

But it wasn’t always like that. Even Home Depot started small, and its rise to dominance was no accident. The business has been well run for decades, as evidenced by a strong return on invested capital (ROIC) that has grown higher over time:

HD return on invested capital (median of 10 years) data of YCharts

What does that mean? Home Depot’s business is efficient; it earns a significant return on every dollar it invests in the business. That can worsen over time, and Home Depot’s sales growth only reinforces that effect.

The result is increasing cash surpluses, which Home Depot uses to pay a growing dividend and buy back stock, further boosting earnings growth and ROI. Home Depot’s stock numbers have fallen 24% over the past decade, and its earnings per share share has increased by 211%.

That’s the magic formula.

Will it continue?

It’s fair to wonder at some point whether Home Depot can continue its success as the company grows larger. Today, Home Depot has a market capitalization of nearly $420 billion.

The company still has growth opportunities. There is currently a housing shortage in the United States, estimated at approximately 4.5 million homes and counting. Home Depot sells to professionals (builders and contractors) and do-it-yourself consumers, so the company has exposure to new home construction and renovation costs.

In addition, the company acquired SRS Distribution for $18.25 billion earlier this year, a specialty distributor in the residential market, opening Home Depot to new verticals such as professional roofing, landscaping and pool construction.

Home Depot estimates its total addressable market at $1 trillion, leaving plenty of room for expansion based on its $154 billion in annual sales. That’s a promising long-term forecast, though investors should note that Home Depot is a cyclical business due to ups and downs in the housing market and spending trends.

Are you shopping Home Depot today? Here’s what you can expect

While Home Depot still has growth ahead, it’s probably unrealistic to expect the same returns the stock has provided investors over the past few decades. Home Depot is a mature company, as evidenced by its pivot to expand and win into new niches. Analysts expect Home Depot to grow earnings by an annual average of 9% to 10% over the next three to five years. Add in the stock’s 2.1% yield, and investors could see annualized total returns of 11% to 13%.

Low double digit returns can compound very nicely, but it will take time. Home Depot is no longer a swing-for-the-fences investment.

Unfortunately, Home Depot’s valuation may dwarf those returns somewhat. The stock trades at a forward P/E of 28, which is high for a company expected to struggle to hit double-digit earnings growth. I don’t think Home Depot, trading at a PEG ratio of 2.8, is so expensive that investors should sell the stock or avoid it altogether.

Still, Home Depot is a maturing, blue-chip stock that has arguably had its best growth years. The company’s high-quality fundamentals make it an excellent consideration for any diversified long-term portfolio, but will buying Home Depot today set you up for life? Probably not.