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Forget Earnings, This Chart Is Bad for Home Depot

Talking Numbers

The hottest trade in the past year has been The Home Depot. It's been hotter than Apple or Google. The Dow component reported earnings this morning. But, with the stock at an all-time high, has it come too far, too fast?

The Home Depot has been on a tear since August 2011. Its shares have more than doubled in less than two years. Now it’s at an all-time high. But is the home improvement retailer a house of bricks or is a house of straw waiting to collapse?

The company released its numbers this morning. Analysts expected its earnings to be $0.77 per share and its revenues to be $18.69 billion for the quarter, nearly 5% more than this time last year.

One guide for where the company is headed is by looking at housing starts in the US. According to the US Census Bureau, the first three months of 2013 saw 2.89 million new homes begun, compared to 2.14 million last year, a 35% jump.

So far, good news for The Home Depot and its arch-rival Lowe’s, right?

Maybe not, because all may not be so hopeful in the future. Unlike April 2012, last month’s housing starts were less than the previous month’s. And that has some investors worried.

Yet a huge cost component for The Home Depot, lumber, is down 15% since the start of 2013. Is this a promising sign that lower inputs will mean higher profits or is it a sign that housing demand is falling?

“There’s almost no debate,” says Carter Worth, Chief Market Technician at Oppenheimer and a CNBC contributor, on the steady, upwards direction shares have gone over the past year. Yet, Worth believes tough times are ahead after looking at the company’s charts. “Complacency at some point leads to hubris. And hubris leads to trouble.”

Worth believes the stock is headed down to $69 per share.

“The key question for Home Depot is, ‘Is valuation too rich?’” says Enis Taner, Global Macro Strategist at RiskReversal.com and a Talking Numbers contributor. “It trades above 25 times P/E [price-to-earnings ratio]. Twenty-five times is far above the valuation during the best days of the housing bubble.”

The company’s high revenues are a hindrance to growing the company at a rate that justifies this high P/E. “It’s a hundred billion dollar sales-a-year company,” says Taner. “It’s very hard to grow that type of revenue 10%, 15% a year.”

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