Few stocks have had a run in 2012 like paint manufacturer and retailer Sherwin-Williams (NYSE: SHW ) has. Shares are up nearly 40% this year, with hardly a break in its uptrend. Is the stock still a buy, or should investors brush this one off? I think it is unlikely that Sherwin-Williams will extend its run much more for one simple reason: The stock has become too pricey.
Take a look at how the company compares with other paint manufacturers and retailers on several key valuation metrics.
Source: Yahoo! Finance. NM = not meaningful due to negative earnings.
The lower these metrics are, the more relatively inexpensive the stock is. Paint manufacturers PPG Industries (NYSE: PPG ) and Valspar (NYSE: VAL ) are both significantly less costly than Sherwin-Williams. Home Depot (NYSE: HD ) and Lowe's (NYSE: LOW ) , both competitors with Sherwin-Williams in retail paint sales, also have lower valuation metrics.
Sherwin-Williams deserves to trade at a somewhat higher multiple than these companies. It outperforms all of them in several key areas, including revenue growth, earnings growth, and return on equity. Sherwin-Williams' ability to control its supply chain more effectively as both manufacturer and retailer certainly gives it some advantages over pure retailers like Home Depot and Lowe's. However, the financial outperformance and structural advantages aren't enough to justify an EV/EBITDA nearly 45% higher than Home Depot's and more than twice as high as Lowe's.
Sherwin-Williams is even expensive compared with itself -- historically speaking, that is. The forward P/E of 17 is higher than every average yearly P/E for the stock over the last 10 years, with one exception (2011). Is the paint market radically different now? Does Sherwin-Williams' paint have a more significant competitive advantage now than it has over the last 10 years? If we answer "no" to these questions -- and I would -- then Sherwin-Williams is priced too richly at current levels.
Mostly smooth rolling
That's not to say that Sherwin-Williams hasn't deserved its market success. 2011 revenues were at an all-time high for the company. Sherwin-Williams has increased dividends for 33 years in a row.
Even though the company is already the largest specialty paint store operator in North America, it's still expanding. Sherwin-Williams opened 60 new stores in 2011 and plans to add another 50 to 60 this year. It's growing internationally also, especially through strategic acquisitions.
The paint margins could be thinning, though. One key area of concern for Sherwin-Williams is raw material costs, particularly for titanium dioxide. The company's Consumer Group has already felt the pain: Its 2011 profit margin decreased, in large part due to these increased costs.
Competitors PPG and Valspar face the same raw-material challenges. PPG reported that 2011 pigment and resin cost inflation more than doubled compared with 2010. Valspar noted in its 2011 10-K filing that gross profit as a percent of net sales was affected by higher raw-material costs.
Sherwin-Williams' financial results are also affected by both the U.S. housing market and the global economy. There are some encouraging signs in the housing market, but not enough to give a real warm and fuzzy feeling. The global economy is tentative at best, with Europe in a mild recession.
Paint runs -- in both directions
Investors fare best when they buy strong companies with attractive valuations that have recent or upcoming catalysts for growth. Spotting these scenarios can result in excellent profits over time.
That was the case for Sherwin-Williams in late 2011 and early 2012. Now we face a different picture. Sherwin-Williams is still strong, but the outlook for more growth catalysts is uncertain. What is certain is that Sherwin-Williams stock is valued on the high end of its historical range and is more expensive than its peers on every measure.
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