Sherwin-Williams (NYSE:SHW) may not sound like an exciting investment at first glance. We make jokes about paint drying, after all. But it turns out that paints and protective coatings are actually an exceptionally good business. SHW stock has powered up from $18 in 2000, to $600 now on the strength of its brand and a savvy management strategy.
The bad news for investors is that the stock has rallied more than 75% since the March lows. It’s clearly not cheap at this point. But the firm is a top-notch operation and may well be worth buying, even now. Here’s what has made the company such a phenomenal investment, and why the good times will keep on rolling.
A Fantastic Growth & Income Machine
With the fall of General Electric (NYSE:GE) and the general malaise in the steel and auto industries, among others, many investors have given up on industrial stocks, at least as blue chip holdings. But don’t throw the baby out with the bathwater. There are some fantastic companies in the industrial space, and Sherwin-Williams is right up there.
In fact, Sherwin-Williams is a Dividend Aristocrat. This means that SHW stock has paid a rising dividend for more than 25 years in a row. In fact, they’ve raised their dividend every year since 1980. The 9/11 attacks and the great housing bust of 2008, among other obstacles, weren’t enough to smudge the company’s track record.
Over the past four decades, the company has delivered utterly breathtaking results. An investor in May 1980 has earned 18% a year compounded over the past four decades.
How’s that shape up in terms of dollars? It’s pretty incredible. $10,000 invested in 1980 would be $6.4 million now without dividends, or $11.7 million with dividends reinvested.
Either is amazing, of course, and it serves as a nice reminder not to ignore dividends, even if the starting yield seems small. SHW stock generally yields around 1% at any given time, which sounds paltry. But when they increase that figure at a double-digit clip, it adds up quickly.
A Superior Business Model
What has led to the decades of success? The first thing to realize is that Sherwin-Williams isn’t just selling paint to average do-it-yourselfers at Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW). In fact, I suspect many investors fail to realize Sherwin-Williams’ favored position for this reason: If you just paint something once every few years in your own house, you probably don’t understand the grasp that the company has on the industry.
Sherwin-Williams’ primary customer is the professional painter, the individual or company that is doing hundreds of jobs every year. Sherwin-Williams offers higher-quality paint than rivals and can charge a premium for doing so.
In addition, the company has nearly 5,000 standalone stores, offering proximity and ease-of-use compared to buying paint from less personal big box stores. That 5,000 store count is a huge number by the way. That’s even more locations than, say, Home Depot. Home Depot has just short of 2,000 U.S. locations by comparison.
Sherwin-Williams has also led the way in making life easier for its professional customers, with high-volume ordering, on-site delivery, and even ordering via mobile phone. In this way, Sherwin-Williams has built up its position with professional painters and now dominates that vital portion of the market.
Why SHW Stock Has Been So Volatile
So if this is such a great company, as I argued above, how did the stock go from $600 to $330 in two months earlier this year? And for that matter, why is it back up to $600 now? Even during the market crash, most high-quality companies didn’t go down nearly 50% and then immediately double off the lows. For a paint company in particular, this probably seems like an excessive market reaction.
The answer is leverage. Sherwin-Williams uses a high level of leverage on its balance sheet. As of the last reporting period, it had $8 billion of tangible assets against $16 billion of liabilities, meaning that they operate at a substantial net debt position (excluding intangible assets).
The debt is manageable. They paid $332 million in interest last year versus $2 billion in pre-tax income, so there is plenty of wiggle room. Still, in a sharp and sudden economic downturn, it’s not hard to see why the market became concerned, at least for a time.
Sherwin-Williams has also delivered a ton of earnings growth over the years through its share buyback program. It has retired nearly 20% of its outstanding stock over the past decade. However, given the company’s high debt position, shareholders are concerned that the buyback may disappear for a time. That’s a valid concern, to be sure. But given the defensive nature of the company, the market overreacted in March.
The Bottom Line
On earnings, the company is now trading at 34x trailing earnings, and 26x supposed forward earnings. It’s fair to be skeptical of forward estimates at the moment given current economic conditions. In any case, SHW stock is no bargain right now.
I’m not going to rush out to pay 34x earnings for the stock. Particularly not, given the less-than-perfect balance sheet. I think you can reasonably support 25x earnings (a $425 price for SHW stock) given the high-quality business and prevailing low interest rate environment. Beyond that, however, you are arguably chasing the stock. Up at $600/share, if you buy the stock, do so while planning on holding for a little while so that earnings can catch up to the stock price.
That said, I’d still rather own Sherwin-Williams, even at this price, than a lot of other alternatives. It’s a fantastic business, and I’m confident it will continue to dominate its industry for many years to come. That’s a formula for success. If shares take another dive, consider taking advantage of the opportunity.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.
