Home Depot’s Lukewarm Performance Goes in Sync with Troubles Spelled by Housing and Mortgage Indices

Assessing future prospects of the U.S. economy and likelihood of major asset purchase tapering going forward, we need to watch more carefully various housing and mortgage indices. For example, recent data suggests that the U.S. Housing was down for September by 1.6% with permits reported down by 7.7%. The reported drop in housing construction worried many as perhaps the first hint at the uneven pace of the U.S. economy. Now we must closely follow the National Association of Realtors’ (NAR) existing home sales report. This report, based on actual home sale closings, also provides input on inventory, prices, and regional sales performance.

Housing health is important because it contributes about 5% to the U.S. GDP each year, taking into account investment in the construction of single and multi-family housing together with the remodeling costs and other associated fees and taxes. Hence, a poor housing market would add a drag to suppliers and many accompanying service vendors as decoration and maintenance of new homes implies elevated shopping and overall consumer activity.

Another way to assess metrics of the housing market is to follow certain industry-related stocks. For example, The Home Depot Inc. (HD) is known as the largest home improvement retailer in the United States. The stock has outperformed the S&P 500 with a lower risk profile year to date, but there are increasing signs of its overheating.

The home improvement company managed to beat its Q2 revenue and earnings per share estimates, but there are concerns as comparable store sales came in light at a 4.5% increase, missing the consensus of 5.61% growth. Furthermore, the gross margin rate was down by 80 basis points, while the number of customer transactions also decreased by 5.8% YoY. It’s a troubling thing.

As disposable incomes have decreased and will decrease in the absence of a new government support even further with potential asset tapering next year, the market for these items is likely to further cool.

It should be admitted that Home Depot does have a solid market position, but since the stock has gained a tremendous 33.65% YTD, which exceeds the S&P 500 own gain by 15%, the time is to look around and measure the pulse. Home Depot's key metrics are all over the place and significantly elevated. The stock's P/E ratio is almost 9% higher than its 5-year average, while its PEG ratio of 0.83 suggests the company's growth to stock growth is 64.19% worse than its five-year average.

Furthermore, Home Depot's price-sales and price-cash flow ratios are trading above five-year averages by 21.18% and 54.07%. Compared to its 5-year averages, its cash payout and dividend coverage are above their thresholds by 34.56% and 7.87%, indicating that further increases in dividend payouts are unlikely.

Home Depot, being a housing market’s traffic sign in a way, is in sync with the worsening housing, homebuilders and mortgage indices, which sends a more clear signal of the impending troubles for the sector, therefore, among other considerations, we don’t recommend owning REITs.