Some investors are considering buying The Home Depot (HD 2.80%) Stocks as a bet on the likelihood that a drop in interest rates will boost the housing market and increase home improvement spending accordingly. It’s an intriguing idea, but skeptics say the housing market’s recovery could be sluggish even in a lower interest rate environment.

For anyone following the home improvement giant, here’s an important number to keep an eye on.

Transaction volume, non-comparable sales growth

In my opinion, Home Depot will indeed benefit from a recovery in the housing market, but it will take time for that development to unfold. The most important metric for investors is transaction volume growth, not comparable sales growth.

The two factors are obviously related, but investors should also consider the impact of average ticket size, not least because inflation-related price increases have helped offset declining transaction volumes. The chart below of Home Depot’s comparable sales, average ticket price, and transaction volume growth demonstrates these relationships.

Data source: Home Depot.

A few points to note: First, year-over-year customer transaction growth turned negative in the second quarter of fiscal 2021, due to difficult comparisons with the COVID-19-related demand boom in 2020. Nevertheless, it is important to note that comparable sales growth was positive through the first quarter of fiscal 2023, largely due to increased pricing.

Second, as average price growth leveled off, Home Depot’s comparable sales growth began to decline in parallel with the continued decline in transaction growth.

The key takeaway is that the same inflation that caused home prices to rise also flattened Home Depot’s comparable sales growth at a time when transaction growth was negative.

But here’s the thing: The Federal Reserve won’t cut interest rates unless inflation is under control. That means it will constrain overall price growth in the economy, including the items Home Depot sells. That means Home Depot may not find it as easy to raise its average price in a recovery. The most important metric to track is an improvement in transaction volume, which will likely lead to higher comparable sales growth as the recovery progresses.

What this means for Home Depot investors

Lower interest rates help the housing market, no doubt about it. They reduce monthly mortgage payments, provide more economic growth, and provide a sense of job security that encourages home sales. The trend of existing home sales is usually the key number that determines end-market conditions for the home improvement sector.

As you can see below, existing home sales began to decline in 2021 while existing home prices skyrocketed, reducing housing affordability. For reference, housing affordability refers to the income level of a typical family to qualify for a typical mortgage, so a higher number means more affordability and a lower number means less.

Simply put, in 2021, home prices rose, affordability fell, existing home sales declined, and ultimately (see chart above), Home Depot’s transaction volume began to decline. While it’s easy to blame the housing market slump on the Federal Reserve, readers should note that interest rates began to rise in the spring of 2022.

Data from YCharts.

Why it might take some time for Home Depot’s transaction volume to increase significantly

If the key to rising transaction volume is existing home sales, it may take a while for that to pick up significantly. The main reason for this is that home affordability remains low. Lowering interest rates will improve affordability, but as the chart above shows, home prices have risen sharply recently. If they start to rise again after a rate cut, affordability will suffer regardless.

Another scenario would be that home prices stagnate or decline. However, falling home prices and an increase in transaction volume at Home Depot would be rather unusual.

Image source: Getty Images.

Where is Home Depot going next?

A recovery in the housing market is likely, but it may be slower than many believe. Home Depot is a great way to invest in a low-interest rate environment, but transaction volume growth should be viewed as a key indicator of progress. As usual, the stock is best viewed with a long-term mindset, and investors will need to be patient.