Still Bullish On Lowe's After Significant Gains But Momentum Could Slow

Lowe’s (NYSE:LOW) shares have returnedtrailing annualized returns . The 5- and 10-year annualized returns for LOW are 30.3% and 27.5%, respectively. The share price has risen sufficiently that there is limited room to run.

Market-Implied Outlook for LOW/h2

I have calculated the market-implied outlook for LOW for the 2-month period from now until Jan. 21, 2022 using options that expire on that date. I have also generated the 3.8-month and 6.9-month outlooks using options that expire on Mar. 18, 2022 and June 17, 2022, respectively.

The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Source: Author’s calculations using options quotes from E-Trade

The market-implied outlook indicates comparable probabilities of positive and negative returns, but the maximum probabilities are tilted towards negative returns. The peak probability corresponds to a price return of -2%. The annualized volatility calculated from this outlook is 27.5%, slightly lower than the annualized volatility outlook that I calculated in June (29%).

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative side of the distribution about the vertical axis (see chart below).

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

With the exception of the small peak in probability at -2% that raises the probabilities of small-magnitude negative returns, the probabilities of positive and negative returns of the same magnitude are very close to one another (the red dashed line is close to the solid blue line).

Theory suggests that the market-implied outlook will tend to have a negative bias because investors, in aggregate, are risk averse and pay more than fair value for risk protection (put options). In this event, the probabilities of negative returns that are calculated to be consistent with the options prices, will be biased to suggest too high a probability of loss. In light of the potential negative bias, I interpret this market-implied outlook for LOW to be slightly bullish.

The market-implied outlook for the 3.8-month period to Mar. 18, 2022 is consistent with the shorter-term outlook. The maximum probability corresponds to a price return of -2.9%. The probabilities of positive and negative returns are very close to one another, although there is a small range of outcomes with slightly elevated probabilities of negative returns. In light of the probable negative bias in the market-implied outlook, I interpret this as a slightly bullish view from the options market. The annualized volatility calculated from this distribution is 30%.

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

The market-implied outlook to June of 2022 is an extension of the view to January and March. The peak probability corresponds to a return of -3.9% for this 6.8-month period. The annualized volatility calculated from this distribution is 30%.

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

The market-implied outlooks calculated for the next 2-, 3.8-, and 6.8-month periods show probabilities of positive and negative price returns that are very close, although there are slightly elevated probabilities of smaller-magnitude returns. The expected volatility is about 30%. These results suggest a slightly bullish outlook for LOW.

Summary/h2

LOW has rallied substantially over the past year for the outlined reasons and the current valuation is somewhat high. The Wall Street analyst consensus 12-month price target is about 8.8% above the current share price (averaging to the two consensus numbers), for an expected total return of 10.1%.

The Wall Street consensus rating is bullish, but a 10% expected return on a stock with 30% volatility is not terribly attractive. The market-implied outlooks to the middle of next year are slightly bullish.

While the price appreciation over the past year reduces the upside potential, I am maintaining my bullish view on LOW.