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Purchase applications are a leading indicator for single-family home sales and housing construction. Yesterday, the Mortgage Bankers Association announced that purchase applications rose 1% in the week of Dec. 7, making it the fifth straight week applications have increased.

This news is an encouraging sign for large home-improvement retailers, including Home Depot  (NYSE: HD  ) , Lowe's  (NYSE: LOW  ) , and Lumber Liquidators  (NYSE: LL  ) . These three companies benefit directly by selling appliances and materials for housing-related projects, serving three customer groups:

  • Do-it-yourself customers, who complete their own projects and installations.
  • Do-it-for-me customers, who purchase their own materials and hire another party to complete the project.
  • Professional customers, contractors, remodelers, or tradesmen.

Investors, take note
Application purchases provide insight on housing demand as well as economic strength and momentum. The financially unstable aren't jumping in line to buy a house. Investors should be mindful of the trickle-down effect that increased housing demand has on the economy in boosting market investments. When purchase applications are on the rise, it leads to more housing construction jobs. Revenue is generated from home sales for both the builder and real estate agent, which is income put directly back into the economy.

Also in line with home sales are purchases of appliances, such as new ovens, dishwashers, and refrigerators, and furniture sales. According to the Federal Bank of St. Louis, consumer spending accounted for 70.8% of our nation's GDP between the years 1982 and 2007. In a broad sense, purchase applications are a good sign for a strengthening economy.

An increase in home purchasing applications is a good sign that the customer base for home-improvement retailers will be shopping sooner rather than later. Here's another fact that bodes well for the retailers: A survey by AARC showed that 8% of respondents plan on remodeling their kitchen during the next 24 months. Another 11% said they plan to remodel at least one bathroom in that time frame. 

Taking the pulse of the housing market
It's good to see that consumers plan on starting renovations, but what about the overall health of housing markets?

The National Association of Home Builders reported on Dec. 6 that the number of housing markets that are considered to be "improving" jumped by 76 for a total of 201 metropolitan areas in December. The index reflects metro areas that have seen improvements in housing permits, employment, and house prices for at least six consecutive months. It's possible this could finally convince those still on the fence about purchasing a home that the housing recovery has real strength.

What this means for retailers
As you can see in the chart below, all three major home-improvement retailers have drastically outperformed the market this year.

^INX Chart

^INX data by YCharts.

But will they continue to outperform in the future? Lumber Liquidators trades at a P/E ratio of 33 while Home Depot and Lowe's trade at 22 and 20, respectively. If you're waiting on the sidelines to invest for a housing recovery, I'd wait for a better opportunity. While the factors discussed here bode well for the housing recovery, it seems these three companies already have the recovery priced into their shares and are too expensive. If you're dead-set on getting exposure to the housing recovery, always remember to dollar-cost average when investing in potentially overvalued companies. 

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Related Tickers

10/21/2016 4:02 PM
HD $126.60 Up +0.35 +0.28%
Home Depot CAPS Rating: ****
LL $19.22 Up +0.12 +0.63%
Lumber Liquidators CAPS Rating: ***
LOW $70.65 Up +0.76 +1.09%
Lowe's CAPS Rating: ****