It’s not often that a company beats estimates and raises guidance only for the stock to be promptly sold-off by investors. Clearly, in the case of The Home Depot, Inc. (NYSE:HD), the market is pricing in some future macroeconomic uncertainty.
The company’s recent earnings were excellent, and gave no cause for the sell-off. The most likely explanation is that investors are starting to fear the future impact of rising rates on the housing market. So is this a buying opportunity in the stock, or is the market right to be concerned?
Home Depot hits a home run
In the second quarter, The Home Depot, Inc. (NYSE:HD) recorded its first double-digit sales increase in over 13 years, and raised full-year earnings and revenue guidance. Indeed, the latter event is becoming a pretty good benchmark for improving conditions within the US housing market.
Clearly the US housing market is doing well this year, but recent rate rises and a fall in new home sales data for July has highlighted the potential dangers in housing. Conditions may well be fine now, but if this turns out to be the peak then buying into home-improvement stores could prove to be a mistake.
Moreover, the valuations on The Home Depot, Inc. (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW) suggest that both companies need an ongoing housing recovery in order to move higher from here.
If you put these arguments together, it is easy to start beginning the case that The Home Depot, Inc. (NYSE:HD)’s prospects have peaked and the stock could fall from here. Is it really that simple?
Why it’s not time to panic
There are four main reasons why investors shouldn’t give up just yet.
Firstly, while rising rates will affect housing affordability, according to historical data, buying a house via a mortgage is still affordable. For example, here is the NAHB and Wells Fargo & Co (NYSE:WFC) housing-opportunity index.
It is an index that Wells Fargo & Co (NYSE:WFC) investors should follow closely, since the bank runs over 20% of the US mortgage market. The index may well have peaked, but continued job gains and increases in average household wealth will help to mitigate the effects of rising rates on the index.
Indeed, Wells Fargo & Co (NYSE:WFC) needs an improvement in new mortgage origination because higher rates are slowing refinancing activity. In response, the bank is taking measures to boost lending, but the ultimate guide to its fortunes will be how the housing market fares in future.
Secondly, homeowner vacancy rates remain low and close to historical norms.