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David Dreman: The Rally Builds Steam; About Home Depot and Lowe's

November 11, 2006 | About:

The trillion-dollar question today is whether this is the last gasp of a four-year-old bull market that has carried the Dow up 65%, or an upside breakout with a 1,000 points or more to come? My bet is that we are in a solid rally that could gain steam as 2007 progresses. But there will be speed bumps along the way.

First, it's impossible to get a good grip on how far the housing slump will go. The optimists state the decline in new home sales is almost over and home construction will bounce back vigorously both next year and in 2008. That's a hard story to buy because of the strong headwinds that await this important industry. Even if new construction is cut back fairly sharply, there is still a large inventory of new units to work off. With diving house sales, stocks of home builders look cheap today. However, proceed with caution. My fellow columnist Laszlo Birinyi finds several a buy, despite weakening earnings. I'd wait a bit.

Housing will come back eventually. Home-builder stocks may be bear traps for a while. But a safer strategy is to buy home improvement stocks. They are near their 12-month lows, are still growing at low double-digit rates, and are not entirely dependent on new home construction for their sales. Home Depot (36, HD ) and Lowe's (31, LOW )both present good value. Home Depot trades at a P/E of 12, with a 10% growth rate and 1.7% yield, while Lowe's trades at a P/E of 15 with a 12% to 15% growth rate and a yield of 0.7%.

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