Home Depot earnings: 3 things to watch

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A Home Depot employee is seen outside a store in Los Angeles, California March 17, 2015. (REUTERS/Lucy Nicholson/File Photo)

Home Depot (HD) investors have pushed the stock to near record highs heading into the retailer's second-quarter earnings report. Here's what investors will be watching for when the home-improvement giant posts its results on Tuesday, Aug. 15.

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Customer traffic

It's a safe bet that the company will announce solid sales growth this week. After all, a rising housing market has powered 5% or better comparable-store sales in each of the last three years. Comps for its fiscal first quarter kept that impressive trend alive and implied continued market share gains. At 5.5%, its growth pace nearly triple rival Lowe's (LOW) result.

Yet looking behind that comps figure reveals a sharp slowdown in customer traffic growth lately. Gains in this metric were 4% in 2015, 3% last year, and dipped to below 2% to kick off fiscal 2017.

The good news is Home Depot has offset the slump with higher average spending, thanks mainly to its success at catering to professional clients. Still, investors will want to see a healthy mix of rising spending and increased traffic. As for the overall growth pace, Home Depot's latest outlook calls for comps to improve by 4.6% for the full fiscal year, for a decent gap over Lowe's 3.5% target.

Profitability

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Profitability is also on a long-term upswing for this retailer, with operating margin improving almost 2 full percentage points since 2015 to 15% of sales. Given that Lowe's is closer to 9%, it's not hard to see why Wall Street is placing such a premium on the market leader these days. Home Depot's stock is valued at about 2 times the past year of sales, or double Lowe's valuation.

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There are many potential factors that could bring profitability lower, though -- especially initiatives aimed at bulking up the e-commerce infrastructure. Home Depot has been pouring investments into this area, and the focus has helped push digital sales up to a solid 6% of the business. E-commerce revenue rose 23% last quarter to mark an increase over the prior year's 19% boost.

With online-based competitors targeting its market niche, Home Depot can't afford to relax its investment pace. It recently rolled out a buy-online-ship-from-store functionality, for example. Improvements like these are necessary to keep customers engaged, but they also might lead to at least a temporary drop in earnings growth.

Cash returns

Home Depot is one of the most financially efficient businesses on the stock market. In fact, its return on invested capital figure is nearly 30% to lead almost all of its fellow Dow components.

The retailer's capital allocation strategy plays a big role in that efficiency as dividend payments and stock repurchases combine to supercharge shareholder returns. Home Depot has spent $7 billion in each of the last three years on share repurchases, pushing the share count far lower in the process. Its dividend, meanwhile, was just raised 29% and its payout ratio target, at 55%, is far more aggressive than Lowe's 35%.

Home Depot is expecting to lower its stock buyback spending to $5 billion this year. However, that was the same total the retailer initially targeted in 2016 before management decided late in the year to hike repurchases back up to a $7 billion rate. CEO Craig Menear and his executive team likely wouldn't make a move like that again in 2017 unless operating results come in surprisingly strong over the next few quarters.

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Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.