With the Dow recently hitting five-year highs it is getting harder to find value in this market. In fact, for the first time in over a year, I’m seeing some sell signals in favorite stocks of mine. But don’t despair. While I recently added some key names to my sell list I still found some very attractive long term investments.
Part of being a successful investor is not only knowing when to buy, but also when to sell. I love oversold conditions and pride myself on spotting them. However, in the same way I spot oversold conditions I also observe the inverse, and that’s when you sell.
For the record I absolutely love The Home Depot, Inc. (NYSE:HD). But recently it has broken through its previous 5 year P/E record high of 22.90. Currently Home Depot sports a P/E of 23.73. Fundamentally, that gets me wondering how much longer this recent climb can continue. Value investors are backing off since the recent price spike has shrank the dividend to 1.70%, however, this yield still comes at the expense of a 41% payout ratio.
Looking at a three-year chart (Figure 1) Home Depot has had quite a run over the last 16 months moving from $30 to well over $66 for a 120% gain in that short time.
Figure 1:
While the stock may be soaring, the fundamentals don’t really support such a move.
Revenue: Looking at past vs current revenue there appears to be little significant change.
Earnings: While margins have been improving earnings growth has not been impressive enough to warrant a 120% stock price increase.
Sales: With a housing rebound taking shape there is speculation that sales might increase. But how quickly the recovery will manifest is largely in debate. I am personally in the camp predicting a slow and steady recovery that will play out over the next decade. Therefore, I believe the huge gains seen recently are premature.
Margins: As noted earlier margins are improving. Year over year profits, ROI, and ROA are all higher than their five year averages. While these efficiencies are impressive given the large scale nature of Home Depot’s operations, the 2-3% improvements are not enough to justify a 120% move higher.
Conclusion: This stock is getting expensive at the $67 level in my opinion. Selling to lock in gains after such a great run never hurts. If you simply must continue to ride this stock please consider a trailing stop in the 3-6% range, taking into consideration your current profit and risk tolerance. I often use trailing stops in conditions exactly like this to ensure that I walk away with gains.
VALE SA (ADR) (NYSE:VALE)
It’s always a bit of a bummer to have to sell a great stock like Home Depot. Fortunately if you can replace it with another quality stock the pain isn’t so bad. I think VALE SA (ADR) (NYSE:VALE) could be that stock. High yield, attractive value fundamentals, and a great future are just a few of the things I’d want to point out to my fellow value investors.
