Home Depot (NYSE:HD) had third-quarter results that were lower than expected. As a result, Home Depot stock has lost 10% of its value in the two weeks since disappointing investors.
The question most investors ought to be asking themselves at this point is whether the 10% correction is a one-off or the beginning of something bigger?
It has been a while since I’ve written about Home Depot, so I’ll lean on my friends at InvestorPlace as I consider my answer.
The last time I wrote about HD stock was Dec. 10, 2018. Although the home improvement retailer’s business was performing nicely, the HD stock price was not, falling 15% in October and hitting $167 by late November. The HD stock price finished 2018 down 6% on the year.
Here’s what I said about HD at the time:
If you own HD stock, I wouldn’t sell it because HD’s business is operating at a very efficient level. If you don’t own HD stock, I’d consider taking a position at these prices with cash in reserve if prices drop into the $160s. Barring obvious signs of a recession, I expect HD to bounce back in 2019.
Home Depot’s year to date total return is almost 24%. And that includes its recent 10% correction. I’d say that’s a bounce back.
Now let’s consider what lies ahead in 2020.
A Recession Brewing
I’ve been saying for some time that a recession was just around the corner. The economy, however, says otherwise. While not running on all cylinders, and nowhere near the 4-6% growth Trump boasted after signing the Tax Cut and Jobs Act into law back in December 2017, it still managed to grow by 2.1% in the third quarter and the housing market has recovered thanks to lower mortgage rates.
In September, Bankrate.com reported that the odds of a recession by the November 2020 presidential election were 41%, according to a survey of economists. Since then, despite the ongoing trade war between the U.S. and China, Bloomberg Economics now put the odds of a 2020 recession at just 26%.
Although the odds of a recession in 2020 appear to have lessened, it’s not beyond the realm of possibility that one could still rear its ugly head. With interest rates much lower today than in 2007, the Federal Reserve has little firepower to fight a slowing economy.
InvestorPlace contributor Jonathan Berr believes that Home Depot ought to be able to weather a possible recession just as it did in 2008.
In Q3 2019, Home Depot had same-store sales growth of 3.6%, 120 basis points lower than Q3 2018. That’s a two-year stack of 8.4%. In Q3 2008, Home Depot’s same-store sales declined 8.3%, 210 basis points worse than in Q3 2007. That’s a two-year stack of -14.5%.
In hindsight, we know that Home Depot weathered the storm, but those are numbers no retailer ever wants to see. That’s especially true for one as successful as Big Orange.
However, from a shareholder’s perspective, Home Depot stock did do relatively well in the last downturn, losing 22% of its value between the end of 2007 and the March 2009 bottom. By comparison, the S&P 500 lost 37% in 2008.
There’s something to be said for history.
The Bottom Line on Home Depot Stock
My colleague believes that Home Depot’s current valuation of 21.7 times trailing earnings (19.7x forward earnings) makes it a compelling buy compared to Lowe’s Companies (NYSE:LOW), its smaller competitor. He’s probably correct as it relates to the two companies.
However, before I recommend HD stock in 2020, I’ve got to see what happens in the fourth quarter. If it continues to experience slower same-store sales growth, I could see HD retreating below $200.
Home Depot reports its fourth-quarter results in late February. I would wait until then before assuming the stock’s latest correction is over and done with.
If you own HD stock, I wouldn’t sell. If you don’t, I’d wait until after earnings. However, long-term, as Berr said, you’ll do well owning Big Orange.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
