Lowe’s Companies, Inc. (NYSE:LOW) stock recently fell 9% on the earnings headline then another 4% along with the market-wide nervousness to presidential tweets of trade wars. The first drop was self inflicted as management could have delivered better results, but the next two red days were exacerbated by the whole market losing its footing globally. Home Depot Inc (NYSE:HD) stock followed in sympathy.
Today I want to go long LOW stock on several fundamental assumptions. First, in a rising rate environment, homeowners will more likely invest in updating their own homes rather than move.
Secondly, the macroeconomic conditions are strong and made better by the tax laws, so there should be more free cash, and some will land inside home improvement company P&Ls. so in either case, LOW stock should benefit.
I debated which to choose, either LOW or HD, but I finally opted for LOW since it just fell on huge relative volume, so it shed a lot of froth on the earnings drop. Also, since management disappointed on this last quarter, they should have operational opportunities which should result in upside next quarter. So all else held equal, Lowe’s incremental downside is less likely than Home Depot’s.
Personally I find myself more often at LOW than HD but that’s because it’s slightly closer to my house. I do notice that more professionals prefer Home Depot, so maybe that’s a huge area of opportunity for Lowe’s. But for now I think they have other, more pressing issues that they need to tackle in their current model.
Fundamentally Lowe’s stock is not bloated, with a trailing price-to-earnings of 20, but I wouldn’t call it a bargain either. Yes, it’s slightly cheaper than HD, but from an absolute comparison it is more expensive than Apple Inc. (NASDAQ:AAPL).
Click to Enlarge Technically, the sharp drop in LOW stock brings it to a multiyear pivot point. The zone around $82.50 served as resistance until last November. The bulls then took it on meteoric 20% rally in mere days. That has all since repriced lower. Often when price retests the neckline of a breakout it tends to serve as forward support. Both bulls and bears will want to fight it out hard over that line.
Since global equity markets are still nervous over a potential trade war, Italian elections and other several threats I cannot assume that the neckline will hold for LOW here. Luckily there are several other pivot points around $80, $76 and $69 per share, so given time, anyone of these areas should hold and therein lie my opportunities.
Instead of risking my money to buy LOW stock with no room to spare, I will use options. There I can build a buffer zone between the current price and my risk level. I am optimistic mid-to-long-term but I have to be cautious over the shorter term while these headlines are in the media ticker-tape. It is important to note that the elevated CBOE Volatility Index (INDEXCBOE:VIX) could be a blessing in disguise in the long run and after the fear abates.
Lowe’s Stock Trade Idea
The Trade: Sell the OW JUL $70 put for $1.50. Here I have a 85% theoretical chance of success. Otherwise and if the price falls below that point then I would suffer losses below $68.50.
Selling naked puts is daunting, especially when the VIX is this high. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the LOW JUL $70/$65 bull put spread which has about the same odds of winning and would yield 15% on risk. Compare this with risking $85 per share here and without any room for error expect a rally profit.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
