Personal Finance : Mutual Funds Hitting Home: Home Depot's Warning Blindsides Many Funds By Ian McDonald Senior Writer 10/12/00 4:43 PM ET

You know that dazed, lost look you see on customers' faces as they wander the labyrinthine aisles at Home Depot (HD:NYSE - news), looking for three eight-penny nails or a bucket of white paint? That's probably the look on some fund managers' mugs today, too.

Not just because of the Middle East violence rocking the markets Thursday, but also because the Atlanta-based home-improvement titan warned investors that its quarterly results would fall below Wall Street analysts' expectations. The reasons: weak retail prices for lumber and building material, slackening consumer spending and a tough comparison with the year-earlier quarter, when weather-related disasters and Y2K spending goosed profits.

The Home Depot news took an especially heavy toll on the retail sector -- and, in turn, the mutual funds that invest in the stocks. The S&P Retail Index was off 7.6% in late-afternoon trading amid heightened concern that the preannouncement season for retailers -- when warnings of earnings and revenue shortfalls roll in -- will be a nasty one. (Retail companies typically operate on a fiscal calendar that lags behind the calendar reporting cycle by a month; hence a delay in warnings.)

While Home Depot has distinct problems that keep the stock from being a bellwether, the warning may augur that mutual fund managers won't find much of a haven in retailers if tech stocks continue to struggle.

The stock, a sterling performer in recent years, was down more than another 27% in afternoon trading on Thursday. It had already fallen more than 28% this year.

Outsize Gains, Outsize Losses Home Depot's stock has outperformed the S&P on both the upside and downside for the past few years. YTD Performance does not include today's losses. Source: Morningstar and Baseline.

The disappointment shouldn't have come as a complete surprise to many, considering Lowe's (LOW:NYSE - news) -- Home Depot's chief rival -- had warned of slackening sales earlier this month, primarily due to weak prices for building materials. Still, judging from recent fund ownership data, it looks as if few growth-fund managers have dumped their Home Depot stakes this year.

On Jan. 1, a whopping 70% of large-cap growth funds owned HD shares and on Aug. 31 (the latest portfolio data available from Morningstar), that percentage had dipped only to 66%. Given the central role big-cap growth funds play in many investors' portfolios, Home Depot's disappointment -- in addition to the market's sudden and significant slide -- will hit many investors hard.

In total, more than 770 stock funds own Home Depot, according to Morningstar.

Even as the economy showed signs of slowing, some investors might have thought Home Depot's efforts to broaden its customer base beyond weekend warriors to include professionals could keep it above the fray.

"There was ample visibility for these [troubling] issues. But Home Depot has a plethora of top- and bottom-line earnings drivers all moving at full speed. Some might have expected these efforts to offset the negatives," says Greg Fontana, an analyst and portfolio manager with John Hancock Funds.

Despite today's jaw-dropping tumble, many believe the stock is still a good long-term pick.

"I'm sure some people saw it coming. It wasn't too hard to read after Lowe's warned," said Mark Sellers, the Morningstar stock analyst who covers Home Depot. "There's no way to predict when this will turn around, but I still think Home Depot is an amazing stock to own long-term. The problems don't look company-specific, they seem to be problems with the economy."

Fontana concurs, noting that Hancock managers had trimmed their Home Depot holdings back in May and June, but still held the stock.

Given the stock's solid performance in recent years, it's understandable that the retailer ended up in so many funds. Given the stock's significant position in the S&P 500 -- the yardstick for most large-cap funds -- not owning the stock is actually a sizable bet against a fund's benchmark. Home Depot is the second-biggest retailer in the index -- behind only Wal-Mart (WMT:NYSE - news) -- with a 1% weighting.

Tool Time? These 10 stock funds have the biggest bet on Home Depot stock. Fund Percentage Assets in HD YTD Return Fidelity Select Construction & Housing 7.6% -9.5% Fidelity Select Consumer Industries 6.4 -14.5 Marsico Focus 5.5 3.1 Huntington Growth 5.2 1.4 Oppenheimer Total Return 5.0 -14.3 Armada Tax Managed Equity 4.7 -0.6 TrueCrossing Growth 4.7 -7.9 Excelsior Large Cap Growth 4.2 -9.1 Wells Fargo Large Company Growth 3.9 -1.6 Enterprise Equity 3.8 2.8 S&P 500 1.0 -7.1 Source: Morningstar. Holdings as of most recent portfolio report.

Of course, some fund shops have been selling their Home Depot stakes. In the second quarter, fund managers at Fidelity, which owns more Home Depot stock than any other institution, sold 8.2 million shares, according to bigdough.com, a Web site that tracks institutional stock ownership. Judging from the stock's fall today, at least some institutions with millions of Home Depot shares in their funds are probably lightening their loads.

http://www.thestreet.com/funds/funds/1123021.html

-- Martin Thompson (mthom1927@aol.com), October 12, 2000