(FORTUNE Magazine) – COULD IT BE that last year every homeowner from southern Florida to northern California paneled the basement, retiled the bathroom, or painted the porch? How else to explain the 45% increase in sales for Home Depot, the Atlanta- based purveyor of paint, planks, power tools, and plumbing fixtures to the do- it-yourself crowd. The discounter built those sales not merely by opening new warehouse outlets; sales in existing stores, the most critical indicator of retail growth, increased about 18%. For most retailers, wringing out a 5% improvement would be considered miraculous. Warehouse stores typically offer shoppers deep discounts with minimal service and back-to-basics ambiance. Home Depot's outlets have all the charm of a freight yard and predictably low prices. But they also offer unusually helpful customer service. Although warehouse retailing looks simple, it is not: As discounting cuts into gross profit margins, the merchant must carefully control buying, merchandising, and inventory costs. Throwing in service, which is expensive and hard to systematize, makes the job even tougher. In the do-it-yourself (DIY) segment of the industry -- which includes old-style hardware stores, building supply warehouses, and the everything- under-one-roof home centers -- Home Depot is the only company that has successfully brought off the union of low prices and high service. The fastest-growing retailer in the industry's fastest-growing sector, Home Depot is hotter than roofing tar. Says Bo Cheadle, an analyst with Montgomery Securities: ''We consider Home Depot to be one of the premier retailers in the United States.'' While merchants in general have been stitching together a 7.1% annual growth rate since 1982, the DIY business is nailing down 11.6%-a- year increases. Home Depot, by contrast, pounded out an 82% compound rate from 1979 through 1986 and plans to grow at 33% for the next couple of years. In the past decade handyman homeowners have overtaken the professionals as buyers of building supply materials. They carried off nearly 60% of these goods last year, an increase of ten percentage points in 12 years. Even when they don't do the work themselves, an increasing number of consumers are becoming BIYs, buy-it-yourselfers, saving the markup that contractors often charge on materials. Analysts like Cheadle make the case that this industry is noncyclical. When consumers can't buy new or bigger homes, they maintain or upgrade existing ones. Thus, the 2% drop in 1987 housing starts doesn't warp the business of companies like Home Depot. Only once since 1970, a period covering three recessions, has DIY spending decreased in constant dollars. It fell 4% in 1981. A growing market does not always mean growing profits, particularly among warehouse retailers. Home Depot's most vigorous competitor, Builders Square, owned by K mart, has had trouble balancing discounting and service. In three years Builders Square opened 118 outlets, building nearly a billion dollars in annual sales -- but zip in profits. Builders Square has mimicked the look of Home Depot but has been unable to match its operation. In cities where the two compete, such as Houston and Atlanta, Builders Square has launched bloody price wars but has only nicked its rival's business.

Builders Square is not the only retailer to whack its thumb trying to hammer the warehouse concept down. Mr. HOW, a division of Service Merchandise, folded in 1986; Bowater Inc. dumped its nine stores on Home Depot in 1985; and HomeClub, a California chain, recently sold out to Zayre Corp. Home Depot's expansion into Arizona and Texas sawed into the margins of conventional home center retailers such as Payless Cashways. W.R. Grace's retail division, once the industry leader, met up with Home Depot in California and threw in the trowel, selling its numerous home center chains, as well as other retail businesses, citing the hostile competitive environment. THE ONLY OTHER shiny gadget in DIY has been Hechinger Co. The profitable Landover, Maryland, retailer takes the opposite tack from Home Depot, running gleaming stores that cater to women shoppers. Now Hechinger has decided to get down and dirty. The company recently acquired Home Quarters Warehouse, a chain in the Southeast. Home Depot's excitable Chief Executive Bernard Marcus, 58, is the charismatic type for whom retailing is religion, and damned if he doesn't believe he's found the perfect church to worship in. ''I'm not saying that no one could copy us,'' he says.''But our competition is going to have to do a lot to keep up with us. We are far from being 100% of what we want. And we're going to get nastier, tougher.'' Marcus is not just preaching. Home Depot's 75 hangar-size outlets, located across the South and West, are raking it in. Analysts estimate that earnings for fiscal 1987, which ended in January, doubled to about $53 million, after tripling the year before. Total sales rose to about $1.5 billion. The first retailer to bring the warehouse notion to the home center industry, Home Depot was launched in 1979 after Sanford C. Sigoloff, the turnaround artist, launched Marcus and Arthur Blank, Home Depot's chief operating officer, out the door of Daylin Corp. The two men were running a Daylin subsidiary called Handy Dan, a chain of home improvement stores. They had begun to experiment with discounting in one Handy Dan outlet and observed that when they marked down items, volume increased and costs as a percent of sales decreased. ONCE DUSTED by Sigoloff, Marcus, Blank, and another dustee, Ronald Brill, now the chief financial officer, put the idea for Home Depot together. They quickly raised venture capital from Invemed, a New York City investment firm, and such private investors as takeover lawyer Joseph Flom and Frank Borman, then chairman of Eastern Air Lines. Marcus and company opened their first store in Atlanta in 1979. After a year they had four stores and were operating profitably. Says Marcus: ''We all worked on the selling floor. Without that kind of hands-on experience, I doubt that we would have been successful.'' In 1981 the company went public at $12 a share; after five splits, the stock was recently selling at $19. From the beginning, the operating premise, like that of warehouse supermarkets, has been that high sales volume driven by low prices can generate wheelbarrows full of profit. The industry has taken notice of Home Depot's pricing tactics. Says Wyatt Kash, associate publisher of National Home Center News, a trade magazine: ''There isn't a home center today that doesn't incorporate some of Home Depot's approach.'' By undercutting competitors and selling his wares at about 40% off the list price, Marcus forced a contraction in the industry's gross profit margins from 40% to 45% in the late 1970s to 25% to 30% today. At Home Depot, overhead is held to a minimum. The store, usually in a suburb, is also the warehouse, with inventory stacked over merchandise displayed on industrial racks. A typical Home Depot chalks up $22 million in sales a year, or about $425,000 a week, more than a big supermarket. Profit margins are better too: 3.6% last year compared with 1% in an average supermarket. What sets Home Depot apart from mere discounters is the company's mission to make a Mr. or Ms. Fixit out of someone who thinks about calling the plumber to change the bath water. Marcus's aim is to demystify the mechanics of plumbing, electrical wiring, and construction. The company undertakes this technology transfer by staffing its stores with knowledgeable salespeople to answer shoppers' questions and guide them to the proper equipment. For example, a licensed electrician is on the staff in most stores. These experts also lead workshops in the warehouses to show customers exactly what the D in DIY stands for. Once the consumers are hooked, the company plots to prevent them from buying anywhere else. While a typical home center might carry 10,000 items, Home Depot stocks 25,000, from tiny screws to giant bathtubs. ''Our people make the difference'' ranks right up there with ''We'll have it for you next week'' as the biggest lie in retailing. But Home Depot's people clearly do make the difference in an industry where the tyro has replaced the pro as the major customer. Part-timers and minimum-wage earners staff most warehouse outlets and many conventional home centers. Home Depot goes the other way. Some 90% of its employees are full time, and they earn higher-than-average salaries with full benefits. THE COMPANY believes in training and then retraining. Employees are required to attend ''product knowledge'' classes -- this week, water heaters; next week, power tools -- and they are paid for the time. Marcus and Blank have personally taught each of the company's 75 store managers and 375 assistant managers, and still spend one day a month instructing each new crop of manager trainees. Marcus believes Home Depot's teaching is so unusual that it renders his employees useless to other, less intense retail organizations. ''Where do we find these people?'' he asks. ''Nowhere. We make them. We tell our people . to make it here because they won't be able to make it at another organization. They'd be misfits.'' In 1985 Home Depot learned the hard way that low prices and good service were not enough without tight operating controls. The acquisition of the nine Texas-based Bowater stores went sour along with that state's economy, and an overambitious expansion program stretched Home Depot management too thin. Earnings for the year dropped 40%, to $8 million, and the stock price fell like a sack of tenpenny nails pushed off a roof. Says Marcus: ''When you're very busy opening stores, there are a lot of little things you don't do, and you soon outdistance the talents and the abilities of your people.'' One of those little things: sales training. The need for bodies in the new stores meant that instruction got short shrift. Even worse, inventory management began unraveling: Some stores begged for merchandise while others got items they didn't need. LAST YEAR the company introduced an advanced inventory management system, which has allowed it to turn its inventory 5.4 times a year instead of 4.5 times. The increased turn means that Home Depot can carry $40 million less in inventory -- the equivalent of 14 stores' worth -- and tie up less working capital to finance it. Bottom line: With its costs lowered, Home Depot can cut margins further if it chooses. The retailer's spectacular growth is now slowing as it adds stores to fill in its existing markets. Inevitably, the new warehouses cannibalize existing store sales, but not by much. Says Blank: ''We thought in 1979 that three stores would be enough in Atlanta, and now we have seven. We are putting up three more and have sites for an 11th, 12th, and 13th. That may be true in every market we're in. We don't focus on competition. We feel that with the mousetrap we have, we can compete effectively with whomever.'' Certainly, Home Depot is going to get its chance to meet a lot of whomever: Twenty-one new stores are abuilding this year. Marcus and Blank don't intend to stop putting on additions until the company is the first national chain in the industry. Home Depot's scouts have been sniffing out the Northeast for more than a year to pin down the right merchandise and the right locations for such cold weather cities as Boston and New York. Says Marcus: ''We want to be the Sears Roebuck of this industry. When I said it in 1979, people used to laugh at us.'' No one's laughing anymore.

CHART: INVESTOR'S SNAPSHOT HOME DEPOT

SALES (latest four quarters) $1.4 BILLION CHANGE FROM YEAR EARLIER UP 44%

NET PROFIT $45.8 MILLION CHANGE UP 144%

RETURN ON COMMON STOCKHOLDERS' EQUITY 15% FIVE-YEAR AVERAGE 17%

STOCK PRICE RANGE (last 12 months) $28-$12.13

RECENT SHARE PRICE $19

PRICE/EARNINGS MULTIPLE 19

TOTAL RETURN TO INVESTORS (12 months to 1/29) 31%