By Bill Barker (TMF Max)
February 9, 2000

As expected, valuation is a prime factor in Rick's argument. I've got to agree that an investor should be cognizant of the current valuation of this company if he or she is going to be investing over the short term -- any period of less than five years. I can easily imagine Home Depot performing fantastically as a company for years, and yet shareholders purchasing at today's prices not being rewarded immediately. That very scenario played out between 1992 and 1996, as the company essentially tripled sales and earnings and the share price didn't go anywhere.

Of course, those that held throughout that time were ultimately very, very well rewarded.

That's what you're looking at today. A beautifully run company that might or might not reward purchasers in the short term, but absolutely will reward patient shareowners if the company continues to perform in line with present and past execution.

OK -- maybe you consider all this buy-and-hold stuff pabulum. Rick's argument, after all, indicates that Home Depot is way overvalued, so let's look at how it got to where it is. The announcements of the company's entrance into the Dow Jones Industrial Average and a stock split announcement have something to do with the recent price surge, but those things certainly don't create actual value for shareholders, so Foolish investors can't look for justification there.

To compare Home Depot's valuation to other world-beating retailers such as Gap Inc., Wal-Mart, and Lowe's, as Rick has done, is quite fair. That comparison does call for some further evaluation, so here goes.

Lowe's: Home Depot has returns on equity of 18.5% vs. 13.9% at Lowe's, a debt-equity ratio of 0.06 as compared to 0.38 at Lowe's, and pretax margins of 9.7% vs. 6.6% at Lowe's. Lowe's is a well-run company. Home Depot is a fantastically run company.

Wal-Mart: With pretax margins of about half Home Depot's (5.4% and stable vs. 9.7% and improving), much slower growth, and much, much, much more debt ($16.5 billion vs. $735 million for Big Orange) it's no wonder Wal-Mart's P/E is substantially lower than Home Depot's. Again, Wal-Mart is impressive -- Home Depot's numbers blow you away.

Gap, Inc.: I won't try to justify Home Depot's price next to Gap's. Frankly, except for all the debt that Gap has taken on lately, it looks to me like Gap is pretty cheap at these prices. Maybe Gap is a better investment at today's prices than Home Depot -- that doesn't make for much of a bear argument, though. By the by -- as to Rick's declaration that the Home Depot doesn't qualify as a Rule Maker, check out the port's own evaluation of that, entitled, "A Case for Home Depot."

Finally, as to the interest rate argument, well, I think the market has already taken Home Depot's price down about 15% in reaction to that. But I'll just say that those types of things never impress me. Didn't Rick and I Duel over the market's returns for 1999? Didn't Rick insist that interest rates would have to come lower for the market to be up last year? Hasn't he learned?

I suppose not. If you think that people are going to stop buying homes because of interest rate concerns, that doesn't matter one whit. That just means people will be fixing up the homes they're already in instead of buying new ones to fix up. Either way, Home Depot wins.

So, by the way, should its shareholders.

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