Source: Home Depot.
Few stocks have seen as much bullishness recently as Home Depot (HD 0.74%), with the home-improvement retailer having climbed to new all-time record highs repeatedly in recent years. Yet even with a host of factors favoring Home Depot's success, investors can't afford to take the company's share-price appreciation for granted. Specifically, three particular trends could eventually conspire to force Home Depot shares lower, at least temporarily. Let's look at these potential pitfalls for Home Depot with an eye toward figuring out whether the company can avoid them going forward.
1. Will an end to cheap credit reduce homeowners' willingness to remodel and renovate?
Home Depot relies on homeowners who want to improve their homes. Whether they're inclined to take on do-it-yourself projects or they hire outside professionals to get the necessary work done, most homeowners need access to inexpensive credit in order to finance the remodeling and renovation projects they do.
Recently, homeowners have enjoyed the best of all worlds on the credit front. Home prices have rebounded sharply from their financial-crisis lows, giving many homeowners equity in their homes for the first time since the end of the housing boom. That in turn has opened the door to cash-out refinancing, which many people use to free up cash for remodeling costs. At the same time, rates have remained extremely low, making refinancing a viable option.
As quantitative easing has come to an end, one of the major sources of downward pressure on interest rates has finally gone away. Most investors don't expect the Fed to start raising rates until the middle of next year, and even once it starts, increases could take a while to take full effect. Yet in the long run, less favorable financing could drive some potential business away from Home Depot, and so investors need to keep an eye on the bond market to make sure that any worsening in rates won't have a dramatic and immediate effect on Home Depot sales.
Source: WestPortWiki, commons.wikimedia.org.
2. Mortgage-reform efforts might not go as smoothly as Home Depot hopes.
Along the same lines as the interest rate environment, Home Depot also relies on financial institutions being willing to extend credit to its customers. Even though rising home prices have allowed lenders to get a little more lax about giving out loans, some institutions are still reluctant to lend because of uncertainties concerning their legal liability if something goes wrong with a particular mortgage or home equity loan.
That said, Home Depot CFO Carol Tome believes that the Federal Housing Finance Agency, which regulates Fannie Mae (FNMA 1.51%) and Freddie Mac (FMCC 1.63%), could finally be moving toward establishing better guidance on lender liability to banks and other financial institutions. By clarifying under which circumstances a bank or other lender will be liable on a loan that goes bad, the FHFA could lead lenders to loosen their lending standards, and that could open up a flood of new customers for Home Depot.
The problem is that there's no guarantee that banks will get the exact assurances they want. If that doesn't happen, then Home Depot might not get the benefits it expects. It's too early to be sure how regulatory moves will play out, but investors need to keep a close eye to make sure their needs are met.
3. Another bad winter could hurt Home Depot.
Last winter, a tough season temporarily caused problems for Home Depot, as shoppers chose not to visit stores during intense cold. Even well into the early spring, which is Home Depot's most important time of the year to drive lawn and gardening projects as well as getting a head-start on projects that have lingered throughout the winter months, the home-improvement retailer had trouble getting its business growing as quickly as investors wanted to see.
Already this year, parts of the country have started off on the cold side, with winter weather already striking the Northeast and portions of the upper Midwest. Home Depot has plenty of locations in warmer-weather climes that could offset bad weather as long as it remains relatively localized. In the event of a repeat performance of last year's terrible winter season, though, Home Depot could once again see sluggishness in its business -- and investors might not be as forgiving this year as they were when they thought such events would be one-time in nature.
Home Depot has made big strides into record territory, and for now, few things stand in the stock's way toward even higher levels. In the long run, though, shareholders need to beware and prepare for possible pullbacks in the stock going forward if any of the three threats above start to materialize.
