Weak Housing Starts: Avoid These 4 Stocks to Tighten Your Portfolio

Source: Thinkstock

Source: Thinkstock

On Tuesday morning, the Commerce Department reported that housing starts in May fell by 6.5 percent. This comes on top of a downward revision of March’s large upswing from +13.2 percent to +12.7 percent. While investors sold of stocks on this news, we should keep in mind that the S&P 500 trades with reaching distance of its all time high, and that there are still excellent selling opportunities for those investors who have yet to take them. In this article, I point out four stocks that are directly impacted by this news but which are also trading at lofty valuations and should therefore be sold.

1. Home Depot (NYSE:HD)

Home Depot is in the home improvement business, and if there are fewer homes being built then there are fewer homes to be improved upon. Thus, Home Depot’s longer term outlook should suffer as a result of this data, especially if it turns out to be a part of a longer term trend.

Home Depot shares have been topping out for about a year now. Shares have traded from the low $70s to the low $80s and every time it has traded above $80/share, it made sense to sell. While you can’t get $80/share, $78/share is still pretty good. The stock trades at over 20-times earnings as investors are optimistic that the company’s past sales growth can continue into the future. However, this headwind, along with tepid retail sales, a declining Q1 economy, and rising prices are all headwinds that threaten this trend.

Ultimately, the risk is to the downside, and Home Depot shares should be sold.

Source: Thinkstock

Source: Thinkstock

2. Lowe’s (NYSE:LOW)

The story for Lowe’s is similar. Lowe’s is also in the home improvement business and so long as there are fewer homes, Lowe’s business will suffer.

Lowe’s trades at a similar valuation as Home Depot, although its growth has been slower over the past few years. The company’s earnings have risen on a per-share basis as management has been aggressively repurchasing shares, although it has been doing so with borrowed money. This makes the company’s stock especially vulnerable to a housing market turndown, the probability of which just increased substantially.

Source: Thinkstock

Source: Thinkstock

3. Sherwin Williams (NYSE:SHW)

Sherwin Williams makes paints and coatings. As people are buying fewer new homes, there are fewer houses to paint and to coat — so this news is a negative for Sherwin Williams. Sherwin Williams has benefitted from the recovery in the housing market over the past few years; sales have grown in the low double digits. However, profit growth due to margin expansion has been more impressive. Profits have been growing at twice the rate of sales growth, and investors have bid up shares tremendously as a result. Right now, the stock trades at 27 times trailing earnings and at 23 times forward earnings estimates as analysts continue to believe that sales growth will continue. But considering the decline in housing starts, investors should be concerned that this growth is at risk. Since the stock is overvalued without this growth, I think the shares are vulnerable to the downside, and investors who have ridden the stock higher should take profits.

Source: Thinkstock

Source: Thinkstock

4. Williams-Sonoma (NYSE:WSM)

Williams Sonoma sells upper end home furnishings. As there are fewer new homes being built, there will be fewer homes that need furnishing, and this could be a problem for Williams Sonoma. The company’s stock trades at 23-times earnings as investors are confident that it can continue growing its earnings at the rapid pace we have seen over the past few years. But this has occurred in a rising housing market in which we have seen a rise in housing starts. A decline in this metric could put pressure on the company’s growth unless it can increase the rate at which it is taking market share. Ultimately, Williams Sonoma is a great company with a reputable brand, but this is largely priced in whereas slowing growth and margin compression due to a decline in same-store sales is not. Like with the stocks previously mentioned, the risk is to the downside.

Disclosure: Ben Kramer-Miller has no position in the stocks mentioned in this article.

More From Wall St. Cheat Sheet: