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Home Depot Drafted New Retail Formula

In 1978 Bernie Marcus and Arthur Blank were hardware executives with no jobs but a big idea.

The two men had been fired from a hardware chain owned by Daylin Inc., a retailer being steered out of bankruptcy by the late turnaround specialist Sanford Sigoloff. But they had something else in mind that turned out to be bigger and better. Marcus and Blank joined with investment banker Ken Langone and merchandising guru Pat Farrah to pursue a vision of a one-stop home-improvement store for the do-it-yourselfer. On June 22, 1979, they opened their first two Home Depot (HD) stores in Atlanta.

What followed was nothing less than a revolution in the home-improvement market, as Home Depot rolled out mega-stores stocking thousands of plumbing, paint, electrical and other products. Home Depot grew to become the sixth-largest retailer in the world, with 2,262 stores and nearly $79 billion in annual revenue in its latest fiscal year. And it became one of the great stocks of the past 30 years.

Home Depot stock, which was already up sharply from its IPO a few years earlier, surged 36,074% from its August 1985 low to its all-time high just last month.

Unfilled Niche

"I'd like to say we were geniuses, but we weren't," Marcus told IBD in a 1998 interview in which he described the company's inception. "People came in and were hungry for (do-it-yourself) information. Arthur and I looked at each other and said, 'Here's a niche we can fill.'

Home Depot's retailing innovation was built on three pillars.

With the stores' enormous product selection, homeowners no longer had to shop at the hardware store, the paint shop, appliance centers, nurseries and other specialty retailers to complete a project. A single Home Depot had all that and a lumber yard.

The first stores sprawled across some 60,000 square feet each, resembling warehouses more than typical stores. Each Home Depot stocked 25,000 products, much more than the average hardware store at that time. To create the impression of fuller stores, the company stacked empty boxes as high as it could.

Today, the average Home Depot store weighs in at 105,000 square feet and some 35,000 products.

Size wasn't the only difference. Home Depot went after the do-it-yourself market, helping customers do their home-improvement projects with a sales staff that could share knowledge about plumbing, painting and other skills. Eventually, it started offering how-to clinics for customers. The supersize stores also caught on with contractors.

Good Timing

Value pricing added a third major element to the company's strategy and gave Home Depot an unmatched advantage.

Marcus and Blank were in the right place at the right time. In the 1980s, the baby-boom generation was moving into its prime homebuying years. Relatively high home prices raised demand for fixer-uppers. And finding dependable and affordable contractors frustrated many homeowners.

Some rivals could figure out how to do two of the three planks of Home Depot's strategy but not all three, says Craig Menear, president of Home Depot's U.S. retail operations and a 17-year company veteran.

The company has become the largest home-improvement chain in the world. It is also the fifth-largest retailer in the U.S., according to the National Retail Federation's U.S. sales ranking for 2013. NRF puts Home Depot as number six in the world.

From its base in Atlanta, Home Depot started expanding in the Sunbelt states and then to the Northeast in the late 1980s.

The company's international expansion started in Canada with the acquisition of Aikenhead's home-improvement centers in 1994. In 2001, it acquired Total HOME, gaining a presence in Mexico. Today, Home Depot has 286 stores in those countries.

One of its most significant acquisitions came in 2006, when it bought Hughes Supply for $3.2 billion. The deal gave Home Depot a construction-materials supplier, which the company used to expand sales to professional contractors.

Success spawned imitators and other new competitors. When Menear started with Home Depot in 1997, the company was facing competition from Lowe's (LOW), which has its own brand of big-box home-improvement stores.

"We pretty much stayed with our strategy," Menear said. One difference was that Home Depot had a heavier focus on professional contractors.

As a stock, Home Depot has had five major advances in its history. The first went from its first day of trading in 1981 to September 1983, when shares soared about 1,800%.

The second climb of 300% was from August 1985 to August 1987.

The third — and best — was from the low in the 1987 stock market crash through 1992. Home Depot shareholders grew about 2,760% richer in that span. Annual earnings surged 211%, 82%, 31%, 42% and 42% in the 1987-91 growth spurt.

The 1980s and 1990s were decades of huge growth for the company. Home Depot was posting solid earnings and expanding its market share thanks to "the twin engines of low costs and a boom in home improvement," an IBD story in April 1991 noted. Manufacturers supplied the chain directly, which helped Home Depot keep costs down.

The fourth great stock surge was from late 1995 to the market top in 2000. That was a 760% boom.

The fifth big rise has come since the 2009 market low; Home Depot stock has surged about 350%.

Oddly, the stock did not track the housing boom of the 2000s. The stock just got dragged along with the bear market of 2000-03. Shares plummeted more than 70% from the April 2000 peak to a bottom in January 2003. By comparison, the Case-Shiller 20-city home-price index climbed 33% from the second quarter of 2000 to the fourth quarter of 2002.

From a 2003 low to November 2004, Home Depot shares more than doubled. The stock, however, peaked long before the housing boom did. The Case-Shiller index topped in the second quarter of 2006, after more than doubling from Q2 of 2000.

Management took some heat. In January 2007, CEO Robert Nardelli resigned with a controversial $210 million severance package. Nardelli, critics said, came to Home Depot from General Electric (GE) with too little knowledge of the retail business, and his GE-style strategies didn't translate well to Home Depot. He was replaced by Frank Blake, another ex-GE executive as well as a former U.S. deputy energy secretary who had joined Home Depot in 2002. Blake remains at the helm today.

A strategic shift led the company to shed its wholesale business and refocus on retail, Menear says. Those businesses were sold to a team of private equity groups in 2007 for $10.3 billion. Those investors took the company public last year — what is now HD Supply (HDS).

Home Depot earnings declined from 2007 to 2010, when the housing market saw a huge contraction. Profits started growing again in 2011. In August of that year, the stock began the major advance that continues today, ahead of the recovery in real estate values that began in 2012.

A few years ago, another significant change in strategy occurred when the company realized online shopping was growing.

"We recognized at that time that there were several things we needed to do," Menear said. That included working closer with suppliers and steering customers at stores to find more merchandise at Homedepot.com. The company's e-commerce has expanded to 600,000 products, about 17 times more than the average store's. Online sales surged more than 50% last year and account for about 3.5% of total revenue.

The baby boomers who helped Home Depot grow in its early decades have grown older, which has resulted in another shift in strategy, from do-it-yourself to the do-it-for-me business.

"You have a portion of the population who is saying, 'Hey, you know what ... maybe I'm at the age where I no longer want to do it myself; I want somebody to do it for me,'" said Menear.

That has led to a relatively new growth focus on the installation business.

"We also are working on product that's simpler, easier to use, that makes the project go faster — and you can build it with more confidence, for younger customers," he added.