Home Depot Reports Solid Numbers But Stock Sells Off – A Warning Sign for the Market?

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For new investors, here’s a basic trading idea that you should begin to understand – if there’s good news on a company and it goes down, watch out.

One of the main drivers for this economic rebound and the move up in the stock market has been with housing related stocks, like The Home Depot Inc. (NYSE: HD).

Home Depot has been unbelievably strong this past year, continuing to drive higher on almost any news.

On August 20, 2013, the company reported second quarter 2013 results that were very strong, with sales up 9.5% year over year, comparable same store sales up 11.4%, operating income up 17.5% and net earnings up 17.2%. On a diluted basis, earnings per share were up 22.8% year over year. (Source: The Home Depot Inc., August 20, 2013)

The company beat the average analyst’s estimates on both revenue and earnings.

Sounds great, and the stock was up in pre-market trading. Things were looking good, but then during the day we saw a tremendous amount of selling pressure.

Following the earnings release, the stock opened at $77.06, hit a high of $77.50 before turning down and closing near the lows of the day. This is a large reversal for a stock that issued a great earnings release.

Looking at where the stock has come from, in July 2011, the stock hit a lot of $26.83, and now HD is over $74 per share. That is a massive run up, that simply can’t be sustained forever. At some point, all of the good news is priced into the stock.

The stock is trading at a forward P/E of over 17 and 6.7 times book value. These are quite expensive metrics for a company that is well-established and sells traditional goods. Can they continue growing? Yes, but not at the rapid rate we’ve seen over the past couple of years.

We think the reason for the sell-off today is that many investors are asking themselves, what’s left in the stock?

Since Home Depot was one of the strengths for the market on the way up, this could be a sign that the market is fully priced. If that’s the case, we could more selling pressure to come.

After all, if this is how the market reacts to good news, how will it react to bad news? We think the sell-off would be quite dramatic.

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