A Classic Lesson on How to Make Money in the Stock Market

The year is 2005, and The Home Depot, Inc. (NYSE/HD) stock is riding high at almost $45.00 a share. But despite strong earnings, the stock starts to break down in early 2006. Earnings continue to be strong, hitting $2.80 a share in 2007, as the stock continues moving lower, finishing out 2007 at $25.00 a share.

It was not until the first quarter of 2008 that Home Depot earnings started to “tank,” as they say in the brokerage industry. The world’s largest home improvement chain recently reported that first-quarter 2008 profit fell 66%. It also said that it would eliminate 1,300 jobs and close 15 stores.

What about the stock price now?

Home Depot stock has actually risen from under $25.00 at the end of 2007 to $27.28 today. What does this mean? For now, it means that the stock market believes the worst is over for Home Depot and that better times lie ahead for the economy.

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In these writings, as the years go by, I’ve been sending one key message to my beloved readers: The stock market is a leading indicator, not a lagging one. You can make money in the stock market by following where the stock market is going.

But you can lose money in the stock market by following the advice of stockbrokers, analysts, investment reporters and journalists who all believe that the stock market responds to news as it happens. These people have failed to grasp the basic fundamental that the stock market has already “discounted” events long before they happen.

The Home Depot case is a textbook classic. While Home Depot reported great earnings in 2006 and even better earnings in 2007, the stock market knew all too well that the housing slump would eventually affect earnings at Home Depot. The stock market responded to what it expected to happen to Home Depot earnings by bringing down the stock price by half in less than 24 months.

Now that the poor earnings have been reported, and now that analysts are coming out and changing the recommendation for Home Depot stock from a “buy” to either a “hold” or “sell” recommendation, Home Depot stock is rebounding from its recent low. Again, I believe that the stock market is saying that the worst is behind Home Depot.

A smart investor would have made a lot of money by short selling Home Depot stock when the stock market started to bring it down in early 2006. That same investor would have made money again by buying the stock in recent weeks, as the stock market brought the stock price up from its 2007 low.

So please, don’t listen to what stockbrokers, analysts, investment reporters and research reports are telling you… listen to what the stock market is saying. You’ll always make money by joining and following where the market is going. As the great hockey player Wayne Gretzky once said, “I don’t go to where the puck is; I go to where the puck is going.”