My single largest bearish position is in Sherwin-Williams ($SHW). As a value investor, I not only look for the things which are "cheap", but more often than not, I look for the assets (stocks, bonds, currencies, etc) that are overly expensive regardless of what the company produces/ sells. I believe Sherwin-Williams falls into this category.
Anyone who has read my posts before knows that I have a very simplistic view of the market: price is a reflection of sentiment. Price tends to lead fundamentals (as defined by revenue, gross profit, and equity). When sentiment gets too far ahead (up or down) of fundamentals, a recalibration is set occur, meaning price returns to a fair value state.
Here is a 10 year look of Sherwin-Williams Market Cap and their Revenue TTM (Trailing Twelve Months):
As one can see, the companies market cap (total shares x price per share) and its revenues have been in sink up until the end of 2011. If price is correct at these levels, then a recalibration of price and revenues would mean Sherwin-Williams would grow their revenues by somewhere between 75-80% over the next couple of years.
As the chart shows, there is a lag time between price and revenue up and down ticks. As the stock market is a forward-looking indicator, price leads fundamentals. However, the question I pose to myself is this:
"During the housing boom, Sherwin-Williams was able to increase their revenues from roughly $5 billion in 2002 to a peak of $8.13 billion in 2008, or an increase of 63%. In this economy, with this housing market, is Sherwin-Williams able to increase their revenues by 75% in just a couple of years or has price moved too far away from the fundamentals and they will meet "somewhere in the middle?"
But this does not tell me the entire story. Sherwin-Williams may be increase revenues incrementally but growing their profits through improved margins and cost control. Here is a look at Sherwin-Williams' market cap and their gross profit TTM:
As the chart shows, in December 2007 Sherwin-Williams has a gross profit TTM of $3.6 billion. Today, that number sits at $4.1 billion, an increase of $500 million, or 14%. If we consider the lag time in price and fundamentals, this would equate to a much larger gross profit in the coming quarters considering the market cap has doubled since they had peak gross profit in 2007 before it trailed off during the recession. Again, I ask myself is this company organically growing at such as fast pace as price shows but fundamentals has yet to reflect or is price just too far ahead (or sentiment too optimistic) about the company's growth?
It could be that the company is doing an "bang up" job controlling costs as we chart the companies market cap vs. their expenses (ttm):
As the chart shows, much like revenues and gross profit, expenses (ttm) are at an all time high.This can be expected as a company grows, so does their expenses. This is where we need to look at their margin performance, starting with their Gross Profit Margin on a quarterly basis:
And here is a look at their Net Profit Margin Quarterly:
When we put it all together (market cap, revenue, expenses, and net income ttm), this is the picture we get:
What do market participants know that the fundamentals have yet to indicate? According to price, fundamentals are indicating massive growth in the companies revenue and profit. Or, like other stocks with similar price patterns in the past, is sentiment too far ahead of fundamentals?
Sherwin-Williams has an equity (book value) of $1.66 billion. This means its price to book ratio is 10x, or in other words the company is trading at 10x more per share than it has equity per share. Their equity position is down from its 10 year high of roughly $2 billion back in Q2 2006. When we look at a 10 year percentage change of the company's assets, liabilities, and equity, here is what we see:
As you can see, since then end of 2007, the growth in liabilities has outpaced the growth in assets and therefore the company has lost some equity even through the trends are beginning to reverse. When we look at the company's market cap to their book value percentage change over the past 10 years, we get the following:
If we look at Sherwin-Williams from a technical perspective, we find some interesting developments. Let's start with a 10-year view, on a monthly basis, of the stock price:
Here is the same chart, however this time with a moving average of one year (12 months) of prices:
In the past two major corrections is Sherwin-Williams, price got ahead of its 12 month average of prices by 22% in late 2006 and 28% in 2010. At the present time, we are 26% ahead of the 12-month average of prices.
In both the '06 and '10 instances a correction occurred. In the case of 2006, we saw a few months of price consolidation before we broke below the average and moved significantly lower before bottoming out in 2009. In 2010, we saw a 3 month correction in which price came down and touched the average before starting a new trend higher.
A look at another 10 year chart, this time using Volume Profile tells us one simple story - the buyers are few and far between but the sellers are even fewer and further between:
Here is a 10 year chart using a regression channel:
So when we put the pieces together we get:
1. A stock that has yet to significantly make a dent in their fundamentals to warrant a rise in share price of over 115% since September 2011 especially considering how price has moved further away from revenues (ttm).
2. An increase of expenses greater than an increase of revenue (ttm) over the past 10 years, leading to a total equity of $1.66 billion, or nearly 10x the company's price per share.
3. Declining (and down-ticking) gross margins since 2009.
4. A price that has moved 26% away from its 12-month average of prices, which has historically indicated selling is to come.
5. A Volume Profile which has indicated smart money has bought from much lower levels however sellers have not taken profits yet.
6. A stock well outside of its regression channel which indicates unhealthy price action whether it is bullish or bearish.
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