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Getting ready for lower rates
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November 2, 2001: 7:28 p.m. ET
The sharp jump in unemployment will encourage the Fed to cut rates again at next week’s meeting -- and Home Depot stands to gain.
By Michael Sivy
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NEW YORK (CNNmoney) - The unemployment numbers reported on Friday were the worst in more than 20 years. In October, the U.S. lost 415,000 jobs, pushing the unemployment rate up by half a percentage point to 5.4 percent. The stock market shrugged off the bad news, however, and the Dow closed up 59 points. Investors expect that the job losses will push the Fed to cut rates again and give the economy even more fuel.
Home Depot, the nation's largest home-improvement retailer, was the biggest gainer in the Dow, up 5 percent. And Lowe's Companies, No. 2 in the industry, gained nearly as much. Housing-related stocks stand to profit from further declines in mortgage rates. And retailing stocks are also beneficiaries of interest rate cuts since lower borrowing costs usually enable consumers to spend more. In addition, those homeowners who can refinance their mortgages typically end up with an extra $150 or so of monthly disposable income.
There's no question the home-improvement retailers offer attractive growth. Both Home Depot and Lowe's are projected to increase earnings at nearly a 20 percent annual rate over the next five years. That puts the companies in the same category as a lot of tech stocks -- but with considerably less risk.
You don't have to spend a whole lot of time worrying whether plywood will be overtaken technologically. In addition, because the home-improvement sector of retailing remains extremely fragmented, well-run chains can continue to grab substantial market share from local competitors.
The key question about the stocks is valuation. Home Depot's earnings have grown at a 29 percent compound annual rate over the past decade. As a result, the shares have carried lofty P/Es, ranging from 27 to 47. Over the past two years, however, Home Depot shares have plunged more than 40 percent, even though the company has managed earnings gains of at least 10 percent a year.
This year and next, Home Depot (HD: up $1.92 to $40.32, Research, Estimates) should post earnings increases in the mid-teens -- and that growth should accelerate further when the economy finally turns up. Yet at $40.30 a share, the stock is now trading at 28 times next year's projected earnings, or nearly the bottom of its P/E range.
Historically, Lowe's (LOW: up $1.68 to $36.80, Research, Estimates) has offered an even better deal. Over the past year, however, Lowe's share price has climbed by 50 percent. As a result, Lowe's longstanding P/E discount has virtually disappeared. At a current $36.80 a share, the stock is trading at 26 times next year's projected results.
Both stocks look like attractive choices for long-term growth investors. But without a larger P/E discount that would provide more of an incentive to favor Lowe's, I'd opt for the leader in the category and plunk my money down on Home Depot.
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