Source: PaxForex Premium Analytics Portal, Fundamental Insight
The spike in inflation that began months ago hit consumers' wallets and forced the U.S. Federal Reserve to quickly raise interest rates to better balance supply and demand. And more recently, the central bank has signaled that it will do everything it can to get prices under control, which could lead to financial stress for many Americans.
As a result of the slowing economy, the housing market has also begun to soften. Could Home Depot, the $295 billion company that serves this very industry, weaken its business and its stock plummet as a result?
Inflation is still raging. In July, the consumer price index was up 8.5 percent from a year ago. This means that the central bank will continue its aggressive policy of raising interest rates to correct the situation. This has caused a significant jump in mortgage rates in 2022. The 30-year fixed rate is now 5.55%, the highest rate since late November 2008 (not counting June 2022).
As mortgage rates rise, which increases the cost of financing, it becomes more expensive to buy a home. This could lead to lower demand and some cooling of the housing market.
According to Redfin, a real estate broker, the average U.S. home price fell for the second straight month in July and is now $413,000. The number of homes sold in July was down 23.1 percent year-over-year. Consumers struggling to pay for everyday items such as food and gasoline are increasingly refusing to buy a more expensive home.
How might the weakening housing market affect Home Depot's business? It has to do with a behavioral economic theory called the wealth effect. During Home Depot's first quarter 2022 earnings report, its chief financial officer Richard McPhail said: "Throughout our history, we've seen that rising home prices are a major driver of demand for home goods. When your home gets more expensive, you look at it as a smart investment and spend more on it." So a weakening housing market can be a major obstacle.
But so far, Home Depot management has said there have been no negative effects. It mentioned that more than half of the homes in the U.S. are over 40 years old. And home prices have risen substantially over the past couple of years, despite a slight downturn recently.
In the most recent quarter (ended July 31), the company's revenue was up 6.5% and net income was up 7.6% over the same period last year. Consumer demand for remodeling projects remains solid, as both the professional and do-it-yourself segments have grown and still have significant volumes of unfinished projects. This is a positive sign for shareholders.
There have been many instances over the past decade where mortgage rates have risen rapidly. But that hasn't stopped Home Depot's business from continuing to gain momentum over the years. From the fiscal year 2011 to 2021 (ended Jan. 30 of this year), the company increased revenue by 115% and diluted earnings per share by 529%. And the company's stock has followed these remarkable fundamentals, rising more than 400% over the past decade.
Home Depot's colossal size may scare off some investors, who may think the business doesn't have much room for expansion. But according to company executives, Home Depot is slowly tapping into a huge $900 billion opportunity, with the home and professional markets valued at $450 billion each. It's not too late to invest in this winning investment, as Home Depot now accounts for only 17% of the industry.
For current shareholders, the weakening housing market combined with rising interest rates is not a reason to sell, as this company still has plenty of market share to gain. And for those on the sidelines, Home Depot's attractive price-to-earnings ratio below 18 -- cheaper than the S&P 500's ratio of nearly 23 -- makes the stock a smart financial choice.
As long as the price is above 287.00, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 291.67
- Take Profit 1: 307.00
- Take Profit 2: 320.00
Alternative scenario:
If the level of 287.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 287.00
- Take Profit 1: 280.00
- Take Profit 2: 270.00
