Home Depot never thought it had stumbled across a magic bullet.
But it did find a surprisingly accurate predictor of growth for the company in the form of an esoteric housing measure that combines new construction, broker commissions, improvements and several other indicators.
The measure, private fixed residential investment as a percent of GDP, worked remarkably well in forecasting growth for the Atlanta-based home improvement company. Until it didn’t.
In December, the company said it was stepping away from PFRI, as it is known, and returning to simply following GDP to predict growth.
“Housing’s just not as important as it has been,” said Carol Tomé, Home Depot’s chief financial officer. “It’s just not that relevant.”
Housing’s grip on the economy is looser than it has been for 60 years, Tomé said.
While PFRI had averaged about 4.7 percent of GDP for that period, it was most recently near its 60-year low of 2.25 percent, CEO Frank Blake said in the company’s fourth-quarter conference call earlier this week. He said the fact that Home Depot saw U.S. same-store sales grow 4.8 percent in 2010 — its first annual increase since 2006 — shows business can improve even while the housing market remains under stress.
“The current environment has caused us to rethink our approach to forecasting and recalibrate the elements of the economy to best correlate to our results,” Blake said in December.
He said that just as Home Depot saw a disconnect through increased sales when the measure stayed low, there is a chance that continuing to use PFRI through the disconnect could later overstate the rate of recovery as its percentage rose faster than sales because it had originally fallen so far.
Home Depot has seen sales growth because of increased remodeling activity, Sanford Bernstein senior analyst Colin McGranahan said, but also because it has moved to take market share in categories like appliances.
He said while it is important for Home Depot to determine the best way to forecast its business, he doesn’t believe GDP is it.
“GDP is the broadest economic measure that exists,” McGranahan said.
Instead, McGranahan said he would like the company to use a subset of PFRI that focuses only on home improvement.
“To say as a home improvement retailer that you’re not connected to housing is ridiculous, it’s silly,” he said.
But the home improvement subset is not always an accurate predictor, said Wayne Hood, managing director of equity research for BMO Capital Markets. He said government data — like the PFRI figure — is often incomplete and assumes that the future will be the same as the past.
Hood said the move to GDP is the right one, as it creates a base that predicts a level of demand. Like all companies, Hood said Home Depot turned to PFRI in an effort to determine what drove demand for its business.
“It’s a constant search for what’s the right metric,” he said.
Richard McPhail, Home Depot’s vice president of strategic business development, said the company had watched PFRI for the past decade, and that it seemed to be most useful when the housing market was more volatile. The company began using it as a performance indicator in 2007, but McPhail said he never knew how long the numbers would hold up.
Recently, it has not been a reliable predictor, he said, as housing statistics like sales and new construction have been out of whack with actual spending.
“Our market is not just homes being sold and being bought,” he said.
Tomé said Home Depot ran correlations against a number of metrics and determined PFRI to be the best before it began using the number.
While she is happy with GDP for the time being, Tomé said she wouldn’t be opposed to returning to PFRI. “The good thing about statistics is they always revert to the mean,” she said. “When it reverts to the mean, it’s more meaningful.”
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