Sherwin Williams

Dear Wall Street Eliter,

The market is oversold – plain and simple. Now is the time to take advantage and play contrarian…

Although any uptrend initiated at this point is susceptible to long-term weakness, there are many signs of a brief recovery. Following a “W” bottom, which looks just like the letter itself, the Dow Jones Industrial Average has managed to draw its line in the sand around 11,500. In fact we’ve bumped off these levels, or at least near them, twice in the past three months.

Okay, so we’ve established a bottom. How can you tell the rally is for real?

Without getting into too much technical garble, here’s what you need to know. Right now, we’re running full speed ahead, gearing up for a major showdown with the bears near 12,750. Although, we’ve tried to break through this barrier a few times before, something tells me this time will be different.

Did I rub the magical lamp, read smoke signals, or rely on gut instinct? Nope.

Instead, I zoomed in on the charts. After all, a picture does say a thousand words. It’s important to see what investors are doing on a micro level so we can get a good feel for the marketplace. Looking at the 10-day hourly chart explains why the Dow has plenty of buying support left to expel. Last Tuesday, we rallied from around 12,260 to about 12,690. After that, we traded sideways in this narrow channel which will serve as an excellent base from which the next phase in this upward climb will begin.

And we’re already seeing signs of movement…

Everything came to a “T” in the road at 12,660. This was the battleground from which a decisive victory by the winner would yield a great reward for the investor who chose to be on the right side of the fence. In this case, the bulls once again sent the competition packing. That’s the thing with momentum – it’s a difficult thing to stop!

The good news is that the bulk of this bullish move has yet to officially materialize. By the time your average investor catches wind from the major financial news sources, valuations will have climbed past bargain prices.

Okay, so we’re the first ones at the table, what next?

Well, I’ve found us a play to be proud of. It’s a play that lags the Dow a bit, but should give you more time to get in at a good price. The company is Sherwin-Williams (SHW:NYSE). To put it simply, they’re the paint product guys.

“Painting the world with beautiful colors, one brush stroke at a time” I’m not sure if Sherwin-Williams has a slogan of their own, but this one has a nice ring to it, don’t you think? With this stock you have three very strong reasons for entering a long position on the play. Let me explain:

The Story

Sherwin Williams, a company with global reach and hometown presence, has been the focus of an ongoing rumor that DOW Chemical is on the prowl looking to acquire and broaden their chemical coatings business.

Akzo Nobel, a multinational chemical coatings company that rivals DOW, took an aggressive approach and wasted no time completing a deal to buyout ICI for $16 billion last year. ICI just so happens to be one of Sherwin Williams’s main competitors in the paint industry.

Buyout Opportunities

The plot now thickens and mounting pressure rests on DOW Chemical to pull the trigger on a Sherwin Williams buyout — if they want to carry weight in the chemical coatings market.

Although it’s hard to predict when a possible buyout might take place, but something tells me a frenzy of buying activity may take place real soon.

Bottom line: Sherwin Williams has a great reputation in the market, holds a great brand, and delivers a superb product. DOW Chemical can afford to wait and miss yet another opportunity which would result in seeing their market share get flushed away.

Fundamentals

Sherwin-Williams has assembled a good list of fundamentals that help support its candidacy for being a buyout target. The company is currently growing at an annual rate of 5.92%, has an earnings-per-share (EPS) growth rate of 12.30% over the next five years, and boasts a return on equity of 40.76% — which is great!

Now it’s time to add the proverbial cherry on the cake. Just for owning a slice of the company, you can sit back and collect the 2.56% yearly dividend that the company pays out.

Just to make sure we’re not buying in at a premium price, I did a little research and found that the current price-to-earnings ratio (P/E) of 11.70 is far below the industry average of 15.30.

Here’s the kicker…

Even with all of this positive data, the company has to borrow money or offer more debt in the form of shares to the open market in order to pay their short-term obligations. This is evident in their quick ratio of 0.60, which is below breakeven at 1.0.

Mmm…I wonder who the white knight in shining armor will be. DOW Chemical perhaps???

Technical Breakout Build Case for Price Appreciation

In the chart below, you’ll notice a few things. First, there’s a giant horizontal line ripping across the chart. This represents the specific price area which the stock has bumped up against many times over the past three years.

When the stock struggles to jump on top of this line, we’d refer to it as resistance. Sometime in mid-2006, SHW managed to claw its way above this line. There was only one problem on it’s way to Pluto, it never tested its base near $50. In most cases, a stock will at least base along it’s breakout level for a while, and then lift off.

Now that we’ve since come back to earth a bit, we’re seeing some good support in the price area mentioned above. A significant amount of buying cashflow is pouring into the stock. Defense of the stock has begun with no resistance in the short-term. We could probably pluck an easy $5 pop in the within a week or two.

Now that we have a solid longer-term outlook, let’s adjust our lens a little closer. The next graph will show you a few developments happening right now on the daily charts.

As stated in the dialogue windows, we’re seeing major support being tested three times, resulting in a powerful bullish day in early April that literally snapped a severe downtrend. This doesn’t happen often and could very well be a solid bottom from which to snap up shares on the cheap.

Now , look to the flag just above the downtrend line toward the right side of the chart. This is your basic continuation pattern. When a stock makes a big move, like what SHW did in early April, it tends to get temporarily exhausted and trade sideways until it can build up enough momentum to spring forward again.

Speaking of springs, that exactly what I want you to imagine. Remember how hard it was when you were a kid, trying to push on each end of the coil until it wobbled out of control and sprung into its original form? Okay, maybe it was just me being bored back in the day…

At any rate, this is what is happening now. There’s all this pressure building from each end. The bulls on one side, and the bears on the other. Eventually this little tug-of-war has to produce one winner. Many times the answer can be found with what the trend was doing before the pattern formed.

With SHW, the trend prior to consolidation was up. This tells us that beside all the other bullish indicators mentioned, we should expect the upward trend to resume its natural course.

So there you have it… a speculative play that pays out a tasty dividend while you wait for the buyout story to unravel.

Our recommendation: Buy shares of SHW at or near $55.01. If you’re interested in playing the options look to buy September 55 calls (SHWIK) at $5.20 per contract.

Good investing,

Kip Morgan
Quantitative Analyst, Wall Street Elite