The truth behind Williams-Sonoma stock drop

The market is usually ahead of the curb when it comes to a stock’s price action. In the case of Williams-Sonoma NYSE: WSM, a recent 6.6% sell-off in the stock has caused a lot of investors to wonder if there is anything to be worried about. It turns out that there could be a few pointers to raise eyebrows, but not enough to lose faith in the long-term value of this company.

For reasons that will become clear to you in just a minute, what is affecting the stock’s price today could only be a minor speedbump on the road to an otherwise spectacular performance. After all, there must be a reason why this stock has outperformed the broader S&P 500 by as much as 32.8% over the past twelve months.

Within the world of consumer discretionary stocks, Williams-Sonoma rides on the same tailwinds affecting other high-risers like SoFi Technologies NASDAQ: SOFI, which just popped by 20% on explosive earnings. What these two share in common is their exposure to the real estate sector, which you can gauge by following the Vanguard Real Estate ETF NYSEARCA: VNQ.

Buy the rumor, sell the news

Considering that there is a quickly escalating conflict over the Red Sea, where the United States and some of its allies are getting involved to stop further attacks on ships, oil has become the thing to watch recently.

Not only are higher oil prices a potential threat for Williams-Sonoma but also the disruption of shipping routes the company must undertake, which directly depletes margins. Of course, to steer markets with a reality check, the company’s CEO expressed the risks that rerouted shipments could have on the future levels – and profitability – of inventories.

Those are the news, and the markets have had up to a week to digest what the rising fuel and shipping costs will reflect in the future financials for the company, so you can probably guess that the 6.6% sell-off in the past few days demonstrates the market’s conclusion as far as a fair price after the news was announced.

The saying “sell the news” remains true here, but what about the other part? The one that calls for “buy the rumor”? Well, the rumor is that the real estate market is about to have a huge swing upward coming from construction stocks, even Warren Buffett bought into it, and that guy is almost never wrong.

Analysts at The Goldman Sachs Group NYSE: GS stated that they expect a breakout in the manufacturing sector of the U.S. economy, which would be sparked by proposed interest rate cuts by the FED itself.

This would apply to the construction sector, as lower financing costs can make it easier for names like D.R. Horton NYSE: DHI to rake in profits, hence the Buffett purchase. More interestingly is the way that Williams-Sonoma outperformed the Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY by as much as 35.6% over the past twelve months.

After such a bullish ride, do you really think that markets don’t have a reason to keep the stock up where it is, if not rising even more? But wait, there’s one missing piece to the puzzle. Equity Residential NYSE: EQR underperformed the rest of the REITs by 10.0% in the past quarter; why is that?

Waterfall effect

If you think about the real estate value chain, who gets paid first when a new house hits the market? Typically, the homebuilders, of course, but Buffett is already a crowd, so what’s next? The new owner must furnish a house as soon as it is sold. Williams-Sonoma is synonymous with the new home experience.

After the housing market starts to flow in this way, the REITs (real estate investment trusts) like Equity Residential begin to see the benefits. Because of this, you won’t see nearly as much performance in REITs as soon as you see it in stocks like Williams-Sonoma.

Before you get lost in the weeds of market mechanics, remember you are considering buying a rumor. So the rumor is that real estate will see a pop-in activity, and knowing what you know now, it becomes clear that Williams-Sonoma is correct at the gates of a new rally higher.

However, rising fuel and shipping costs pose a significant threat to the business, and you shouldn’t ignore it. Though you can rest assured that, despite its near all-time high prices today, Williams-Sonoma stock still presents a long-term bargain.

With ROIC (return on invested capital) of 28.0% on average over the past five years, this stock could keep on compounding your wealth, as the stock price action tends to match – on an annual return basis – the longer-term ROIC averages.

More than that, its 13.9x price-to-earnings ratio gives you a 22.7% discount to the S&P 500’s 18.0x multiple. Knowing what you know now, do you think all the bad news are priced in with this recent drop?