Back on Jan. 1 of this year, if you’d asked 100 investors what one of 2012’s hottest stocks would be, odds are good none of them would have said Sherwin-Williams (NYSE:SHW). However, the paint manufacturer’s stock is well into all-time-high territory, up 45% year-to-date.
Yet Sherwin-Williams has doled out that big rally for a reason so rarely seen anymore: Investors like the growth the company’s achieving!
That’s right. Sherwin-Williams has earned its stripes. That doesn’t necessarily mean the stock is a screaming buy right now, however. See, the downside to that 45% gain since the end of December is an extremely overbought condition. Investors who are mulling a new position in SHW now might want to think about a couple of things first.
Well, Whaddya Know?
If the name Sherwin-Willams rings a bell, it might be because of its status as a dependable dividend play. The stock hasn’t disappointed, but for reasons well beyond the dividend.
Contrary to popular belief, the construction market isn’t getting better — at least not in a meaningful way. Oh, last month’s annualized build rate of 492K new homes was better than the multiyear low rate of 388K seen when things were at their worst in early 2011. But, the current figure still is well under the peak annual construction rate of more than 1.8 million single-family homes in early 2005.
So how is it that builders like Pulte Homes (NYSE:PHM) and Hovnanian Enterprises (NYSE:HOV) have whittled their losses down to practically nothing since 2007’s and 2008’s catastrophes? Don’t be misled — these homebuilders haven’t recovered. They’ve simply shrunk their way to (relative) success. By scaling back the size of their entire businesses, there’s less loss to book. Pulte’s revenue last year was about half of its 2007 level, while Hovnanian’s top line in 2011 is about one-fourth of its size from just four years earlier.
That’s not to say there hasn’t been money in the construction business, however. It’s just been displaced thanks to the real estate crimp.
Rather than moving, people are remodeling. If you don’t believe it, chew on this: Although Home Depot (NYSE:HD) saw a modest dip in revenue in 2009, last year’s top line of $70.4 billion is within striking distance of 2007’s peak revenue of just under $80 billion. Lowe’s (NYSE:LOW) actually generated more sales last year than it did in 2007. While Lowe’s might have been a little anemic on the earnings growth front, it has been OK, and Home Depot has been downright phenomenal, posting near-record per-share profits of $2.47 last year.
Great, but what’s any of this got to do with Sherwin-Williams?
Quite a bit, actually.
It’s the Easiest (& Cheapest) Way to Spruce Up a House
Think about the reason Lowe’s and Home Depot have managed to do well at a point in time when they really shouldn’t have. In simplest terms, home improvement has been the beneficiary of the real estate implosion. Most consumers are afraid (or unable) to commit to another real estate loan, but none of them are afraid to plunk down a few bucks on a new paint job to make their current house feel new.
The proof of the pudding lies in Sherwin-Williams’ numbers, and particularly 2011’s top line. The $8.7 billion it generated in sales last year was a company record, even if profits didn’t reach record levels.
Yes, it really is as simple as “people are buying more paint.” And given the trend at hand, Sherwin-Williams has ramped up its revenue expectations for the rest of this year, by 7%.
Too Much, Too Fast
Normally one would think all that past and future success would be a boon for shareholders, and it has been. It’s not like the market’s response to the good news has been headache-free, though.
At the beginning of the year, Sherwin was a smart dividend idea — before an insane 45% rally, the dividend yield around 3% and the P/E around 15 made sense. With the former now at 1.2%, though, and with the trailing P/E at 28.5, one has to wonder just how much more price appreciation there’s left to dole out.
To the company’s credit, it has a great history of rising dividends matched to its rising earnings. Ten years ago, SHW was paying around 15 cents per quarter. Now that quarterly payout is 39 cents, with no skipped or reduced payouts in the meantime.
Still, it’s tough to stomach getting in at such a near-term high knowing the yield is so tepid … especially if you’re seeking income above growth; the company’s just not apt to crank up the payout enough to justify the current price anytime soon.
Bottom line? Right stock, wrong time. It’s a great income-producing buy, but only on a significant dip from here.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.