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Model Vs. Market

Model Vs. Market – Sherwin-Williams Co.

By August 4, 2015No Comments

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

– Warren Buffett

In this week’s Model Vs. Market we’re looking at Sherwin-Williams Company. Here is some background on the company:

Sherwin-Williams Company is engaged in the development, manufacture and distribution of paint, coatings and related products for use in a variety of commercial and industrial activities. Its business is divided into four segments: Paint Stores Group (architectural paint and coatings), Consumer Group (third-party marketing of core products), Global Finishes Group (licensing, manufacturing and selling of core finishing products) and Latin America Coatings Group (coating products for Argentina,Brazil, Chile and Mexico).

The firm’s market presence spans North and South America, Asia, Europe and the Caribbean region. It operates over a hundred manufacturing facilities worldwide, including the US, UK, Argentina, Canada, China, Italy, Mexico and Uruguay. The company was incorporated in 1884 and its headquarters are located in Cleveland, Ohio.

Sherwin-Williams is a wonderful company. It is a leader in its market, has impressive profit margins, and generates more than 20% on its invested capital. But, is it available at a fair price? It looks a little expensive based on our discounted cash flow model.

What is Sherwin-Williams worth?

model_vs_market_chart_sherwin-williams

Our valuation model is indicating that shares of Sherwin-Williams are worth $116 which is 58% less than its current market value. Here are the key assumptions used to arrive at this value:

  • Revenue Growth – Over the last 5 years revenue has grown at an average rate of 9.4%. The model assumes the same growth rate for the next 4 years followed by a terminal growth rate of 2.5%.
  • Profitability – Over the last 5 years the EBITDA margin has averaged 12.2%. The model assumes this same margin going forward.
  • Depreciation – Depreciation in 2014 was 1.8% of revenue. The model assumes this same rate of depreciation going forward.
  • Income Taxes – The average effective tax rate for the last 5 years was 32.9%. The model assumes this same effective tax rate going forward. Increasing the effective tax rate to 40% reduces the valuation to $101 per share.
  • Capital Investment – Over the last 5 years the company has spent 2.7% of its revenue on capital investments, net of dispositions. The model assumes the same level of investment going forward.
  • Working Capital – After netting out cash, short-term investments and short-term debt the company operates with positive working capital. The model assumes this will continue at the same rate as revenue grows.
  • Discount Rate – The assumed cost of equity is 10% and the assumed cost of debt is 3.5% over the 10-year U.S. treasury rate. Since the company has little debt ($2.3 billion) the average cost of capital is 9.54% in the model. Reducing the cost of equity to 8% increases the valuation to $169 per share.

This model was created by extrapolating the last 5 years of performance into the next 5 years of performance. Before making an investment decision you should run your own model with your own assumptions based on your own research of the company. Download this model to perform your own valuation and let us know what you think shares of the company are worth on Twitter @tagnifi.

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Disclaimer: The information on this web site is not intended to provide investment, tax, or legal advice, and nothing on the site should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by TagniFi or any third party. You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation.