Jeff Reeves's Strength in Numbers: Why every investor should be terrified by Home Depot’s slide

While the FAANG stocks have gotten a lot of attention over the past few years, one of the most reliable growth stories on Wall Street was actually a big box retailer: Home Depot.

Since 2008, shares of Home Depot Inc. HD, -0.80%  have surged almost 600% compared with about 110% for the broader S&P 500 SPX, -0.57%  in the same 10-year period. That was for good reason, as revenue consistently marched higher, from about $71 billion in 2008 to roughly $100 billion this fiscal year, and its annual dividend soared from just 90 cents a decade ago to an expected $4.12 per share in 2018.

This performance is noteworthy for any company, but particularly for a store that had to deal with both the fallout of a housing crash as well as the pressures of e-commerce.

But lately, some cracks have started to appear in Home Depot’s stock. And increasingly, it looks like there could be serious structural problems brewing for the consumer sector more broadly.

Here’s why Home Depot may be in store for further declines — and why all investors should pay attention, whether they own this stock or not.

What’s behind Home Depot’s recent declines?

The most obvious sign of trouble at Home Depot is the stock’s recent decline of about 13% from all-time highs in January. It’s easy to write some of that off as simply the stock falling victim to market volatility in February, but it’s more complex than that.

For starters, these declines came even as Home Depot earnings were quite strong, featuring a beat on both the top and the bottom line along with strong forward guidance. With a report like that, if investors were really just caught up in short-term market trends they would have eagerly come back as buyers when the dust settled.

But they didn’t.

There’s a host of reasons for that, but a few to consider include:

Margins under pressure: While the headline numbers were encouraging, Home Depot saw a contraction in its profit margins.

Valuation: Even after the drop, this home-improvement retailer still has a fairly rich price-to-earnings ratio that’s just shy of 18. Other big box stores are significantly lower; top competitor Lowe’s Cos. LOW, -0.40%  has a forward P/E of just 14.

Ugly charts: With a steep drop in share price from the January high coupled with a steady drop in volume, the momentum seems to point more to the downside rather than to a floor.

These signs point at the very least to another rough few weeks ahead for Home Depot shareholders. But as I said previously, there are also some worrisome big-picture trends at work that all investors should take notice of.

Is Home Depot the canary in the coal mine?

In a vacuum, it’s fairly straightforward to dissect why this stock has had a bad few weeks. But stocks don’t behave absent of broader market trends, and it’s important to look at the context.

Consider that retail sales have fallen for three months in a row, most recently the 0.1% decline from January to February. That’s worrisome by itself, but the decline is even more troublesome given that plenty of consumer confidence measures continue to post sky-high readings. Furthermore, the theoretical stimulus of Republican tax reform efforts in December should have hit affected consumers’ emotions, if not their pocketbooks.

Read: Home sellers now use spycams to gather intel on prospective buyers during open houses

Speaking of tax reform, Home Depot is the post child of corporations benefiting from last year’s tax legislation thanks to operations that largely exist in the United States. With a prior effective tax rate of around 36% projected to become a rate of just 26% in 2018, you would think the stock would see a sustained lift. While tax reform fueled a 25% surge for the stock, the momentum lasted only about eight weeks from mid-November to mid-January before petering out.

And worst of all, there are increasing signs that housing in America could be about to roll over. Sure, home prices have remained strong, but that’s thanks to record low inventory. Consider that the number of previously owned homes on the market at the end of 2017 had dropped by 11% to just 1.48 million units nationwide, the lowest since the National Association of Realtors began tracking data. That’s particularly bad for Home Depot with its fixer-upper retail business, but it’s also a bad sign for housing in general considering that existing homes represent about 9 out of every 10 transactions.

Read: Buying a home this spring? Brace yourself for some tough decisions

Of course, the builders may not have it much better. Thanks in part to fears that housing is overheated and that rising interest rates will drive up costs and tamp down demand, housing stocks as a group have been in rough shape lately. The iShares U.S. Home Construction ETF ITB, -1.38%  is down about 8% year-to-date and the SPDR S&P Homebuilders ETF XHB, -1.19%  is down almost 6%. Individuals builders including D.R. Horton DHI, -1.01%  and NVR. Inc. NVR, -2.33%  are down by more than 12% so far this year.

So let’s review: Despite record consumer spending and the theoretical boost of a tax cut, the entire housing market has seem to have hit a wall. And despite a fourth-quarter report that featured decent growth and a long history of outperformance, investors have abandoned Home Depot stock and don’t look to be coming back soon.

That’s indeed big trouble for this stock. And if these trends are working against this big-name stock, it’s worth wondering how these headwinds will weigh across other consumer-related plays in the months ahead.

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