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Your deep dive into the "boring" company that's returned 142% in the past 5 years

Your deep dive into the "boring" company that's returned 142% in the past 5 years

May 24, 2022

This “boring” company has returned 142% in the past 5 years BEFORE dividend re-investment. Check out my DD on Sherwin-Williams (SHW) below!

Highlights

- Sherwin-Williams has long been the leader in paints and coatings and its product selection is poised to withstand a coming recession

- SHW pays a small 0.93% yielding dividend but has increased its dividend for 44 consecutive years

- SHW is currently trading at 37.82x P/E, overvalued in my opinion for a company that’s guiding for high single-digit revenue growth

Thesis

Sherwin-Williams (SHW) is a world-renowned seller of paints and coating materials used by DIYers and contractors. With their 4,400 worldwide locations, distribution channels through Lowe’s, and stable demand for their diversified paints and coatings offerings, SHW is poised to benefit in the future as well as in these current inflationary times.

Positives

SHW has many positive catalysts, and the first one I’d like to bring up is that they have a diversified portfolio of paint and coating products. SHW is best known for their world-renowned paint, but they also own Valspar, Thompson’s WaterSeal, Miniwax, Cabot Premium Woodcare & more. SHW has a product for any indoor or outdoor project and while the business has some seasonality with spring and summer being its stronger months, they have products that are bought and used year-round like paint.

The next positive for SHW is the shift in consumer tastes. SHW has benefitted from the past couple of pandemic-riddled years when consumers began to reinvest in their homes. I can speak from experience that consumer demand for paint was BOOMING during the pandemic. I was working at Home Depot at the height of the pandemic and the paint line was out of the building daily. What remains to be seen is whether or not these consumer tastes hold up but it’s a pretty safe bet that people will continue to use SHW products in their home projects.

Another positive for SHW is its worldwide presence. They have operations in North and South America, with additional operations in the Caribbean region, Europe, Asia, and Australia. In addition to its 4,400 stores, SHW also distributes its products through its exclusive partnership with Lowe’s, which adds another 2,200 locations. Last but not least with the addition of Sika AG, SHW also now has products sold in Germany, Poland, Austria, and Switzerland.

Negatives

There are some negatives to consider when examining Sherwin-Williams. Q1 earnings showed tightening margins, with adjusted net income per share (diluted) down 21.8%. No one is safe from the jaws of inflation and input costs have eaten into SHW’s bottom line. It is also worth noting that during recessions people tend to do fewer home projects and the missing sales brought on by DIYers will only make margins slimmer.

Shares of SHW at this point are also overvalued in my opinion. The company trades at 37.82x P/E (price to earnings) and at the time of writing, the S&P 500 trades at 20.31x P/E. Management at SHW is guiding for high single-digit revenue growth but trading at almost DOUBLE the S&P 500’s P/E ratio is absurd to me. SHW’s average 5-year P/E is 25x and with significant headwinds to face, the current valuation of 37.82x P/E is too high for me.

There’s also the little voice in the back of my head that tells me to worry about companies who were “Pandemic Darlings” (see ZM, TDOC). With all due respect, SHW is a much better company with a more proven track record than ZM or TDOC. However, after seeing the carnage that ZM, TDOC, and stocks like them have gone through lately, I’ve grown to be cautious of stocks that were huge beneficiaries of COVID. I’ve seen valuations get slashed big time in a matter of days and SHW may receive that soon.

To make matters worse, SHW has to deal with a paint shortage on top of everything else. Raw materials like linseed are hard to come by, due to Canadian wildfires. Petroleum, a necessary ingredient to paint production, is tough to get as well. Petroleum production was slowed due to ice storms and freezing temps in Texas and to top it off, demand has skyrocketed for paint during the past 2 years. SHW has an enormous task ahead of them in navigating the precarious supply chain, but a company as successful as them doesn’t come this far without adapting and overcoming bumps in the road.

The Dividend Breakdown

For those that don’t know, I mainly use 3 metrics to assess the quality of a company’s dividend. The first is the Dividend Growth Rate, which I use to assess the company’s ability to raise dividends and combat inflation. When assessing the Dividend Growth Rate, I look at the 10 Year Compound Annual Growth Rate (CAGR) because it’s usually the longest-term data readily available and more indicative of long-term company trends. The second metric I use is the Dividend Payout Ratio, which tells me how much of the company’s profits are going to shareholders. The Dividend Payout Ratio also shows me how much room a company has to grow its dividend before it becomes unstable. The last dividend metric I use is Dividend Yield. Dividend Yield tells me how much “bang for my buck” I get as a shareholder. Yield isn’t everything, but it’s nice to see how much money I’ll get back as an investor in the next quarter.

With that being said, I’ve developed a scoring method for rating a company’s dividends that I’m excited to share with you all! It consists of the previously mentioned metrics scored out of 5 and each score is multiplied and weighted by importance. The highest possible score a company can receive is a 31, and members of the Dividend Aristocrats club will receive an extra point for their long-standing history of reliable dividend raises. Each metric has its own criteria which I’ll share below:

Dividend Growth Ratio is the most important metric for me, so scores will be multiplied by x3
Dividend Growth Ratio of 0%-5% is a 1, 5%-7% is a 2, 7%-9% is a 3, 9%-12% is a 4 and a rate of more than 12% is a 5
Dividend Payout Ratio is the second most important metric, so scores will be multiplied by x2
Dividend Payout Ratio of 95% or more is a 1, 75%-95% is a 2, 55%-75% is a 3, 35%-55% is a 4 and a rate of less than 35% is a 5
Dividend Yield is the least important metric of the 3, so scores will be multiplied x1
Dividend Yield of 0%-1.5% is a 1, 1.5%-2.5% is a 2, 2.5%-3.5% is a 3, 3.5%-4.5% is a 4 and a rate of more than 4.5% is a 5

SHW scores are shown below:

SHW 10 year Dividend Growth Rate (CAGR) is 16.41%, obliterating the Materials sector median of 7.18%. Their Dividend Payout Ratio is 32.1%, well within the margin of safety with room to grow their dividend over time comfortably. Their dividend yield is only 0.93%, however, that’s more indicative of a rising share price, which is also good for shareholders. Lastly, SHW is part of the exclusive Dividend Aristocrats club and has shown 44 consecutive years of dividend raises. This notable achievement earns SHW an extra point, bringing its total to 27/31 points. As you can see, SHW touts a highly respectable dividend with the potential to reward shareholders for a long time.

Final Thoughts

After weighing the positives and negatives, I’ve decided to hold off on initiating a position in SHW. The biggest thing holding me back from investing in SHW is the current valuation. I believe the company is trading at too high of a multiple for the growth management is guiding for.

I also have concerns with their shrinking margins. Input costs have risen for just about every company due to inflation, but some companies are handling it better than others. A place like Starbucks for example has the pricing power to pass off inflationary costs to consumers. This is evident by their ability to raise prices 3 times in the past 12 months and in my area, the line is still out the door. I question SHW’s ability to raise prices in tandem with inflation rates not seen in 40 years, but we’ll soon determine whether they can.

This is not to say Sherwin-Williams is a bad company! SHW has a phenomenal history of dividend growth, a plethora of products across paints and coatings, and a wide moat due to its brand loyalty and worldwide presence. Materials is an underrepresented sector in my portfolio and I’m looking to add to it as I see Materials as a sector that holds up well during recessions. SHW is a great company, but the entry point at this time is not right for me.

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