When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider The Sherwin-Williams Company (NYSE:SHW) as a stock to avoid entirely with its 38x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
Recent times have been pleasing for Sherwin-Williams as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Is There Enough Growth For Sherwin-Williams?
The only time you'd be truly comfortable seeing a P/E as steep as Sherwin-Williams' is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a decent 8.9% gain to the company's bottom line. EPS has also lifted 23% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Looking ahead now, EPS is anticipated to climb by 9.4% per annum during the coming three years according to the analysts following the company. That's shaping up to be similar to the 10% each year growth forecast for the broader market.
In light of this, it's curious that Sherwin-Williams' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Sherwin-Williams currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
It is also worth noting that we have found 1 warning sign for Sherwin-Williams that you need to take into consideration.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.