There is a list of about a dozen or so businesses that I have never gotten a chance to talk about because they have always been overvalued. 3M is one of those companies that is incredibly diversified in a Johnson & Johnson meets Honeywell meets Kimberly-Clark kind of way, and I have known darn well that investors in the stock have been able to sit back, collect their dividend that rises 7% or so every year on average with at least some increase coming in all economic conditions, and reap those 11-13% annual returns.
If your goal is to search for those opportunities that enable you to make a single buy decision, then kick back and become a beneficiary of the passage of time as distribution facilities increase, efficiencies in the manufacturing process are introduced, new products are developed, prices are raised, stock is repurchased, and dividends are paid, 3M stock is starting to move into the picture.
I haven’t been able to write about this stock for the past couple of years because the stock was trading over 20x earnings. Not only was there not any margin of safety in the price, but it was an example of paying up for quality under the theory of “I’ll take some lumps for a few years, but then I’ll make it up from years seven onward.” There is nothing wrong with that point of view, especially if you are a high earner as an entrepreneur or professional and the point of investing for you is to inventory profits from your labor and achieve reasonable growth rather than rely upon market-beating returns as the primary driver of wealth creation.
Just last year, the stock was trading at $259 against earnings per share of $9.96. That was a P/E ratio of 26. 3M’s P/E ratio wasn’t even 26 during the dotcom bubble years! Even during the Nifty Fifty days, it was only trading at 24x earnings. There was no time in the past half-century when 3M was more expensive than it was last year, on a normalized P/E basis.
If you follow management’s conference calls, you are aware that 3M is expanding its industrial and safety equipment division into China, having grown these two division by approximately 33% annualized over the past five years (but these Chinese sales from these two segments only represented about 5% of 3M’s overall sales). With talks of a trade war, and manifestations of increasing tariffs between the United States and China, 3M stock has been on an extended decline from $259 to the current price of $174.
In a testament to 3M’s earnings power and diversified base of profits, earnings are still expected to increase to $10.90 over the course of 2019. This puts the valuation at 16x earnings, or my idea of fair value. It’s not on sale. It’s a great business at a fair price, compared to a great business at an expensive price as we saw for the previous five or so years.
The dividend yield is now 3.3%. In the past twenty years, the best average yield for an entire year was 2009 when the stock yielded 3.2%. And the company is only paying out half of its profits as dividends, compared to 45% on average over the past twenty years, so this isn’t one of those cases of a dividend yield increasing due to a company deciding to pay out two-thirds of its profits as dividends rather than one-third.
I haven’t read 3M’s annual report the past two years because the price was self-evidently expensive. Now it’s looking like it’s trading at something close to fair value. I’ll have to take a look again.
Also, the cumulative nature of investing is one of the things that makes it enjoyable. You develop your own institutional memory and can spot deals as they come rather than having to approach every situation fresh as though you were encountering it in the wild for the first time. If you were able to figure out that “x” equals 5 when presented with 3x=15 five years ago, you can figure out “x” equals when presented with 6x=30. Once you study a large business in-depth once, the knowledge of your study remains accessible years later unless you reviewed a business that was subject to some significant M&A activity or operated a business model with a heightened technological risk.
It is also a reminder of Ben Graham’s adage that, if you wait long enough, you will almost always get your price. 3M is one of the best businesses in the entire world, but it’s one of approximately 50 excellent businesses. You only have to identify one of them at a time. If the others are expensive, you’ll wait. At some point within the next 60 months, you’ll probably get your price. Take solace in the fact that there is some other excellent business giving you that “once-in-sixty-month” type of value at the moment and focus your efforts there.
In 2025, I expect that 3M will be earning around $15 per share and trading at a valuation of 17.5x earnings (assuming no recession). That is a stock price of $262.50 per share (note: I use this figure for simplicity and don’t actually believe that a particular multi-billion business can have its entire intrinsic value calculated down to the decimal point). That is a CAGR of 7.09%. But you also get a starting dividend yield of 3.31%. That is 10.4% returns with no dividend reinvestment, and probably somewhere in the 11% range for someone who can reinvest all dividends in a tax-advantaged account over the same time frame. It’s not Warren Buffett finding the Washington Post in 1973, and it probably won’t beat Apple or Alphabet, but hey, it’s a fairly high probability of double-digit compounding in a safe manner. If we were to line up every publicly traded stock in the United States and measure it’s performance through May 13, 2029, 3M should find itself in the top quintile of overall performance.