Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW) have managed to prosper through a sluggish economy, and investors who went against the grain and bet on these stocks in late summer 2011 have been well-rewarded. From their lows of Aug. 8 through Wednesday’s close, HD and LOW had returned 52% and 43%, respectively. Now, it looks like it may be nearing time to cash in.
The issue with these two stocks isn’t one of fundamentals, but of timing. The outlook for both remains favorable, as analysts foresee earnings growth of 17.7% for HD and 11.8% for Lowe’s in 2012, and estimates for both stocks have risen in the past 90 days. Both also pay a dividend north of 2%. Still, consider the following:
Valuations Are Becoming Stretched
HD’s trailing P/E is 18.7, near the high end of its eight-year range and well above its five-year average of 16.1, and it is similarly extended in terms of both price-to-book and price-to-sales. Lowe’s currently is trading at 19.1 times trailing earnings, also at the top of its longer-term range and more than 20% above its long-term average of 15.8. Both stocks are trading above analysts’ mean price targets. Valuation alone isn’t a timing device, of course, but this indicates the risk-reward profile begun to swing into unfavorable territory.
Technicals Are Questionable
HD and LOW are 21% and 14% above their 200-day moving averages, which puts both in an “overbought” range that historically has preceded negative returns in the subsequent three- to six-month period.
In addition, Lowe’s — currently trading in the low $26s — is pushing up against the $27-$28 level that has served as a resistance point twice in the past year. On both occasions, failure at this level preceded meaningful downturns. Home Depot, for its part, is right up against the $43.50 level that marked its high in the 2004-06 period and that currently represents longer-term resistance. HD also sports an RSI above 70.
It’s important to consider that the fundamental economic trends that affect both of these companies — consumer spending and housing — have improved somewhat, but not to the extent indicated in their share prices. With these stocks already up more than 40% from their lows, the recovery in these two areas of the economy will need to be more convincing to justify further gains from here.
Neither stock is in danger of an imminent meltdown. But after the outstanding gains of recent months, it appears that they need to pause for a breather before they can move much higher from these levels. Similar to housing stocks, this looks to be a prime opportunity to sell calls if you’re already in these stocks, and to exercise patience if you’re looking to buy.
Home Depot reports earnings Feb. 21, and Lowe’s reports Feb. 27.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
