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Sherwin-Williams (NYSE:SHW) reports earnings tomorrow, July 19, 2012. The board of directors has already declared a regular $0.39 per share dividend. Analysts are expecting Sherwin-Williams to have a strong year. However, a quick glance at the earnings and price correlated F.A.S.T. Graphs™ on Sherwin-Williams (see below) paints a striking picture of overvaluation even considering the high earnings expectations for this fiscal year. Therefore, investors should be wary if Sherwin Williams misses the estimates.

As per the company's website:

As the nation's largest specialty retailer of paint and painting supplies, Sherwin-Williams is dedicated to supporting do-it-yourselfers with exceptional products, resources to make confident color selections and expert, personalized service that's focused on unique project needs. Sherwin-Williams is committed to environmental responsibility in both manufacturing processes and finished products, and in 2011, earned the EPA Presidential Green Chemistry Challenge Award. Sherwin-Williams products can only be found at its more than 3,400 neighborhood stores across North America.

Earnings Determine Market Price

The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Historical Earnings, Price, Dividends and Normal P/E Since 1998

Click to enlarge images.

Performance Table

The performance results associated with the earnings and price correlated graph validates the principles regarding the two components of total return: capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.

When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 11.1% capital appreciation, long-term shareholders of Sherwin-Williams, assuming an initial investment of $100,000, would have received an additional $45,951.00 in dividends that increased their total return from 11.1% to 11.8% per annum vs. 3.7% invested in the S&P 500.

The following graph plots the historically normal P/E ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as high as it has been since 1998.

A further indication of valuation can be seen by examining a company's current price-to-sales ratio relative to its historical price to sales ratio. The current price-to-sales ratio for Sherwin-Williams is 1.47, which is historically high.

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1. The rate of change (growth rate) of the company's earnings.

2. The price or valuation you pay to buy those earnings.

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 17 leading analysts reporting to Capital IQ forecast Sherwin-Williams' long-term earnings growth at 13.1%. Sherwin-Williams has medium long-term debt at 30% of capital. Sherwin-Williams is currently trading at a P/E of 23, which is above the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Sherwin-Williams' True Worth™ valuation would be $177.94 at the end of 2017, which would be a 7.5% annual rate of return from the current price.

Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in Sherwin-Williams to an equal investment in 10-year Treasury bonds illustrates that Sherwin-Williams' expected earnings would be 6.1 times that of the 10-year T-Bond Interest. (See EYE chart below.) This is the essence of the importance of proper valuation as a critical investing component.

Summary

This report presented essential "fundamentals at a glance," illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it's imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.


Source: Sherwin-Williams Paints A Picture Of Overvaluation