Shares of paint company Sherwin-Williams (NYSE:SHW) have been on my watch list for a while now. After recently reaching a 52-week high of $54, the stock has drifted back down to $46.21, or only about 13 times trailing earnings. The combo of a low multiple and a solid underlying business is usually the recipe for a juicy stock purchase. So what's kept me from investing?

The company's track record has certainly been impressive. Sales growth has averaged just more than 8% for the last 10 years, while earnings have grown at about 11% over that time. Results over the last couple of years include double-digit growth in sales and earnings.

Over the last three years, free cash flow has exceeded net income, excluding a large acquisition in 2004. Excess cash has since gone toward reducing debt to about 26% of total capital, as of the end of 2005. For the latest full year, I estimated free cash flow at $4 per share, ahead of reported diluted earnings of $3.28 per share. As a result, returns on capital tend to be quite high, too.

In addition, the company's outlook shows continued strength. Sherwin-Williams primarily sells its paint via about 3,100 company stores throughout the U.S. It also manufactures paint for third parties and automotive clients. The company projects continued growth as it expands its store base and makes strategic acquisitions to supplement internal expansion.

The key item holding back the stock is Sherwin-Williams' years of legal battles over lead-paint litigation claims. Lead paint was banned back in 1978, after it was shown to have caused brain damage and health problems in children; lawsuits against firms that sold lead paint first began to show up in the late 1980s. Since that time, the company noted, it had not had a successful ruling against it, and investor concerns were starting to subside. But in February 2006, the state of Rhode Island unexpectedly ruled that Sherwin and other defendants, including Millennium Holdings and NL Industries (NYSE:NL), must clean up any lead paint used in buildings there.

In hindsight, DuPont (NYSE:DD) made a stellar move in settling with the state for about $12 million and avoiding a trial. The ruling opened up quite a bit of uncertainty, because those remaining in the suit are pursuing an appeal. It's not clear whether insurance may cover potential cleanup costs, or if other states such as California will look to reopen or pursue cases against paint companies.

Litigation represents a serious overhang on a company with an otherwise compelling valuation. Using a two-stage implied free cash flow model, I estimate that Sherwin-Williams needs to grow only about 7% annually for the next 10 years to justify the current stock price. (Major inputs include a 3% terminal growth rate and a 15% discount rate.) If we assume that the company can grow cash flow at 7% per year for 10 years, then take 10 more years to slow to the terminal growth rate, it could be worth as much as 15% more than the current price. This appears very reasonable, given its strong historical track record, but may not appropriately factor in paint litigation risk.

It's really unfortunate that after this many years, Sherwin-Williams has lead paint issues holding it back. The company even reportedly stopped selling the stuff before it was officially banned. All one can do at this point is await further news from the Rhode Island case.

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to further discuss any companies mentioned. The Fool has an ironclad disclosure policy.