It shouldn’t come as much of a surprise when I tell you that the housing market is in a bit of a funk.
According to data from Redfin, home sellers currently outnumber buyers by an astronomical 57.9%, the largest gap in the 13 years for which they have data, and more than double the next-largest gap of 28.6% in July of 2014.
Mortgage rates are near multi-decade highs (today’s national 30-year fixed-rate average is 7.43%), many prospective sellers are unwilling to move on from once-in-a-lifetime rates they secured during the Covid era, and median housing prices are still in the stratosphere.
Those factors have combined to suppress existing home sales, which have been pinned near Great Recession levels (at an annualized rate of about four million) for the last three years.
And that’s been bad news for companies that thrive alongside the housing market, like Home Depot (HD), which is down 30% in the last year and 15.5% in the last five.
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As you can see in the chart below, HD is firmly in “falling knife” territory.
But Home Depot is a well-established name. It’s the world’s largest home improvement retailer, with nearly half a million employees in more than 2,300 stores in the U.S., Canada, and Mexico.
The company has weathered various housing market storms over its 47 years in business (most notably the Great Recession) and also pays a healthy dividend (3.3%).
So, while it’s undoubtedly a falling knife right now, it’s also one worth catching… eventually.
That begs the question of when investors should begin looking past the housing market malaise towards a brighter future for this blue-chip retailer.
Assessing Home Depot’s Trailing P/E Ratio
A good place to begin searching for an answer is the company’s price-to-earnings ratio.
Home Depot currently trades at a trailing-12-month price-to-earnings ratio of 19.6, which is very close to its 10-year average of 19.5.
In a relatively normal environment for housing (and thus home improvement spending), this might mark a reasonable point to start looking for a bottom.
But given that the home improvement environment is far from normal, let’s consider looking back further to the 20-year average P/E ratio, which sits at 16.5.
That period includes the Great Recession, and that ratio may be more effective at capturing some of the ongoing difficulties Home Depot faces.
With trailing earnings of $14.20 per share over the last 12 months, Home Depot would need to trade at 234.30 per share to reflect the longer-run multiple.
That would take a further 16% decline in the share price.
On first impression, absent a clear sign of a technical bottom in the stock, that’s a reasonable place to begin looking for an entry.
But what if mortgage rates keep rising, sellers start slashing prices, and the wheels well and truly come off the housing market?
In a scenario like that, we can look back to Home Depot’s valuation during the Great Recession.
From Q4 2007 through Q3 2009 (which encapsulates the 18-month “official” recession), HD traded at an average trailing P/E ratio of 9.45, which would give us a target price of 134.20, or a further 52% decline in the share price.
I do not expect HD to reach those levels anytime soon.
But at that price, we’d be well past “falling knife” and into the “Buy when there’s blood in the streets, even if it’s your own” stage.
For the time being, Home Depot is not a knife worth catching, but it’s probably worth keeping tabs on as it falls.
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