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Home Depot Stock Might Be Getting Too Much Respect

To understand how much respect Home Depot (NYSE:HD) gets from the market, just look at the price of Home Depot stock. The stock gained last week; in fact, it touched an all-time high before a recent, modest pullback.

Home Depot Stock: Is HD Getting More Respect Than It Deserves?

Source: Helen89 /

Those gains came after the company missed Wall Street revenue estimates and lowered its full-year same-store sales guidance.

In this market, that combination for any stock — let alone one with macro and tariff concerns — would have sent investors fleeing for the exits. Instead, the HD stock price actually rose more than 4% after the earnings release.

There’s a case that, at this point, Home Depot has earned the benefit of the doubt. It’s a great American retailer, with a likely $110 billion in sales this year. Home Depot stock has been one of the best stocks in the entire market. Valuation concerns in the past — and I’ve raised them as recently as April — have proven to be short-sighted.

That said, investors are giving Home Depot an awful lot of credit. In fact, they’re treating HD stock like a defensive play, not a cyclical one. That seems risky in this environment, and suggests that maybe this time, the HD stock price finally has gone too far.

Home Depot Stock Rises on a Guidance Cut

To be sure, Home Depot’s Q2 report wasn’t a disaster by any means. Earnings beat consensus by 9 cents. Same-store sales still increased 3%, including a 3.1% print in the U.S. The consolidated 3% gain was just 0.2 points below analyst estimates.

And the general take on the quarter seems to be, as one analyst put it, that it “was no worse than feared“. Even with modest signs of a housing slowdown (particularly in new construction) and potential impacts from the U.S.-China trade war, Home Depot is still growing sales and keeping operating margins basically flat. The lower revenue outlook is coming in part from deflationary prices in lumber (although tariffs are a factor as well).

That said, the HD stock price doesn’t seem to incorporate “no worse than feared”. A 20x+ multiple to updated fiscal 2020 (ending January) guidance doesn’t sound that high. But this is a cyclical stock — one whose sales and profits will plunge in a recession.

Even that aside, the lower guidance is a concern. In late 2017, Home Depot gave a three-year target for comp growth of 4.5-6% — it’s missing that mark. Margins are nearing the low end of the company’s target range. Earnings-per-share rose less than 4% year-over-year: pre-tax income actually declined.

Investors are clearly betting on a stronger second half. But the issue here is that Home Depot can’t drive that improvement all on its own.

The Concerns About the HD Stock Price

After all, Home Depot needs help. It needs the economy to hold up. In many places elsewhere in the market, investors hardly seem confident on that front.

Admittedly, the iShares U.S. Home Construction ETF (BATS:ITB), my pick for the Best ETF of 2019, has gained 33% so far this year. But those gains have come simply from regaining some of its lost ground.

ITB is up only 5% over the past year and still sits ~13% below January 2018 highs. And it’s not like Home Depot stock — a major component of that ETF — hasn’t joined in on the 2019 fun. It has risen 27% despite better performance heading into this year.

Meanwhile, other macro-sensitive stocks — think Caterpillar (NYSE:CAT) or automotive stocks — have struggled and/or seen big sell-offs amid tariff and trade war worries. Home Depot’s U.S. focus gives it exposure to the still-strong U.S. economy, admittedly, but on the whole investors still see at least some kind of downturn coming in the next few years.

That’s one big risk. The other is competition. Lowe’s (NYSE:LOW) is trying to execute a turnaround and it’s having some success. Its stock soared after earnings. Its same-store sales have outpaced those of Home Depot for the last two quarters. Home Depot isn’t losing its crown any time soon, to be sure, but a combination of a weaker market and lower market share — even if both impacts are modest — is not priced in at 20x+ FY20 EPS.

A Cyclical Treated Like a Defensive

And yet the HD stock price keeps marching higher. What’s interesting about the trading — particularly this year — is that Home Depot stock really hasn’t been rattled much by outside forces. It posted some big declines in 2018, but the biggest dip so far this year came from late April through late May, when the stock dropped about 9%.

That’s a surprise given the fact that the market as a whole has, at times, been seized by selling amid tariff concerns or an inverted yield curve. A cyclical play like HD stock theoretically should be vulnerable to those swings, but it simply hasn’t had much in the way of downside.

Instead, Home Depot stock has traded more like a defensive stock. Its chart looks much more like that of Microsoft (NASDAQ:MSFT) or a Procter & Gamble (NYSE:PG). Those stocks aren’t immune to macro worries, but they’re generally considered “safer” plays for investors worried about overall growth.

It certainly seems like, particularly after last week’s earnings, the market is treating Home Depot stock the same way. But that would be a mistake. If a recession hits, Home Depot sales will fall. And so will the HD stock price. Investors ignore outside worries — and guidance cuts — at their peril.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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