“Monster Manufacturer” from Dividend.com

Dividends for 99 years, with 50+ years of raising the dividend... who is it?

By Travis Johnson, Stock Gumshoe, September 28, 2016

I’ve been seeing “teaser” emails coming around from Dividend.com for a little while now, and this latest one generated a few reader questions so we’ll get a quick solution out for you today.

The spiel is that this “Dividend Aristocrat two times over” is doing great and has room to increase the dividend further… and that if you sign up for “Dividend.com Premium” you’ll see this pick as well as all the others on their “Best Dividend Stocks List.” We’re not going to cough up $149 just to name this “Monster Manufacturer” for you, but we can certainly check out the clues and get you started on your research…

Here’s the basic pitch:

“Its stock price strength, yield attractiveness, estimated earnings growth for 2017, dividend reliability and attractive valuation make it stand out in our DARS model. The stock has had a 20% return so far in 2016 excluding the dividends. The last 5 year annualized dividend growth of this stock is over 14%.”

So that sounds pretty good, right? It’s not as sexy as a mining stock that might go up 500% on a big discovery, and there’s plenty of evidence to suggest that dividend growth stocks are at pretty high valuations these days, but certainly investing in the strongest “raise your dividend every year” stocks over the past 50 or 100 years has been the best path to relatively low-risk, market-beating returns.

And apparently this specific company was a part of those great long-term returns… it’s been paying a dividend for 99 years, we’re told, and increasing the dividend every year for more than 50 years (you have to raise the dividend annually for 25 years to be a “Dividend Aristocrat”, so that’s where the “dividend aristocrat two times over” bit comes from).

That puts them in pretty rarefied air… and, to be fair, it also makes it fairly easy to ID the stock — there ain’t many that have hit those marks.

The “payout ratio” is in the mid-50s, according to the ad — that means they pay out not much more than half of their income as a dividend… and the current yield is listed as 2.45%, which isn’t so high but looks pretty decent next to a 10-year Treasury note (particularly since the dividend has grown at a very good pace — bond coupons, of course, do not grow).

So…. hoodat? This is the multinational manufacturing conglomerate 3M (MMM).

And… you probably don’t need me to tell you anything about 3M. They make post-it notes, which is where most of us encounter 3M in our daily lives, but they also make thousands of other products around the world — their big segments beyond consumer products are industrial and health care, but there probably aren’t a lot of businesses that aren’t touched by 3M in some way. It’s a big company, and they’ve been around almost forever.

That’s not to say 3M has been a great growth stock forever — they went through a pretty moribund period before the financial crisis when the stock pretty much stayed flat for five years, and the dividend was around 2.5% back then as well, so there have certainly been some pretty long periods of time when you would have had to be really, really patient as a 3M investor… but over the long run it has certainly paid off. And their reorganizational efforts, including cost cutting and “lean six sigma” initiatives over the past ten or fifteen years really started to pay off once the 2009 recovery started, which has helped the stock double over the past five years.

So although we do run into the “law of large numbers” with these kinds of stocks, where we have trouble imagining that a huge company could see its stock price double, we should remember that $50 billion is also huge… and this $50 billion stock has doubled since late 2011. The growth rate may well slow, and it might be that 3M shares are a little pricey for some investors at the current levels, but “it’s already big” isn’t usually a good enough reason by itself to avoid a strong company. Big, strong companies don’t always win when new competition comes into the marketplace, of course, but they do have the wherewithal to out-innovate or acquire smaller competitors, and over time the best of them have a tendency to get bigger and stronger.

3M shares right now are priced at about 20 times next year’s expected earnings, and those earnings are supposed to be 7.5% higher than the current year’s earnings (with revenue growth of about 3%). That’s slightly below 3M’s target of 8-11% earnings growth over the next five years, but that’s pretty good earnings growth for a company this size. It does, however, mean that you’re paying a fairly steep price for that growth with a PEG ratio of about 2.5.

(The PEG ratio is price/earnings/growth rate, popularized by Peter Lynch as a quick way to assess the valuation of growth companies — between 1-2 is generally pretty appealing, all else being equal, below 1 indicates a potential bargain or an odd situation, over 2 means investors are paying a lot… though these “guidelines” have all gotten pretty skewed and may arguably be out of date after seven years of zero interest rates. According to Yardeni Research The current PEG ratio for the broad market is about 1.3, and the current PEG ratio for the S&P industrials sector is about 1.75.)

The payout ratio is nice and low, at about 55%, so 3M does indeed have ample room to raise the dividend even if earnings growth slow. 3M has a fantastic balance sheet, they have an extremely manageable amount of long term debt and it doesn’t cost them much. And they have a huge number of customers around the world, so they don’t rely on just one business or customer, or even on just one sector. That gives me a lot of confidence that a 3M investment doesn’t pose much of an “existential risk” — they’re not going to go out of business in a few years, and their products aren’t fads or easily replaced technologies that will be supplanted… and they continue with the tradition of innovation that has served them well for a century. So I expect they’ll be around and profitable 50 years from now.

The risk is that you might be paying a bit too much for the shares at this point, particularly if the market softens in the next year or two and investors start to flee from even “safe haven” stocks like 3M and the other “blue chip” candidates that fill the portfolios of a lot of dividend growth and “widows and orphans” investment investors. Low interest rates have driven interest in dividend stocks sky-high, and 3M may well not have another spurt of improvements in terms of cost cuts or rising return on equity in their future, so there may not be that market-beating growth in either earnings or dividends.

But those are not company-specific risks, those are market and valuation risks that apply to most of the megacap “safe” stocks. Many of them have risen tremendously in five years, and there’s certainly downside risk.

3M has generally bottomed out at a trailing PE of about 13 when things have gotten tough over the past 30 years, so that’s a reasonable number to keep in the back of your mind when you’re thinking about downside risk — if 3M had a trailing PE of 12 right now, the shares would be at about $104. So if investors around the world woke up tomorrow and decided that 3M deserves a PE of 12 tomorrow, the shares would have to fall 40%. That’s unlikely in any immediate scenario, of course, but if we go through a period of malaise for a bit it’s likely that PE ratios (and therefore stock prices) would drop considerably even if the actual earnings for 3M continue to be relatively steady.

On the other side, we could also return to the days when large cap stocks with some growth are idolized and valued even more richly than they are now — the standard example of that is the early 1970s and the popular “nifty fifty” stocks that traded at PEs in the high 20s, 30s and 40s despite having relatively staid growth rates, and despite the fact that the economy was about to hit some real weakness. 3M was a member of that “nifty fifty” back then, and carried a PE ratio of about 40 in 1972… so if people get super-enthused about these stocks again and want to pay 40 times earnings, there’s still room for 3M to come close to doubling again (at current earnings, that would be a price of $320 per share and a market cap of about $200 billion).

3M has outpaced the broad market this year (up 20% vs. 8%), and that’s been the case for a while — the total return is about 160% vs. 100% for the S&P 500 over the past five years, and if you go back ten years it’s even more dramatic, roughly 200% returns for MMM and 100% for the S&P. So it’s not a beaten-down value stock, to be sure, the company has been doing better than average, and they’ve been rewarded for that — so part of the question for investors is whether you believe they’ll continue to do at least as well as, pr perhaps a little better than, the broad market… and whether the risk of some black swan event for 3M (like an accounting scandal, or whatever) is worth whatever outperformance the stock might show over the market if it continues its current trajectory. You always have more risk in a single company than you do in a broad market index fund… but if you choose the strongest stocks, and 3M has certainly been in that camp over the past 30 years (or more), you should do better than the indexes most of the time to help compensate you for taking that risk… even as MMM’s broad and diversified product mix means it is one of those stocks whose “natural” revenue growth should be similar to the global economic growth rate.

You can get a decent overview of 3M’s businesses from their latest “Investor Day” presentation here, from March, and it’s worth checking that out as well as reading the recent filings and earnings call transcripts (latest is here), but this is a huge, diversified and complex company — you and I are very unlikely, as individual investors, to have any great insights into the specific potential of any of their product lines or new innovations or initiatives that could give you a better sense of real earnings power than the analysts have… I generally think we should save that kind of deep dive research for the small caps, where an individual might get some real insight, and let the professional analysts model earnings for megacaps like 3M. All we have to decide is how much we’re willing to pay for those earnings.

There have been five and ten year periods when 3M has done worse than the market, sometimes much worse, but there haven’t been any long periods I can identify during the last 30 years when a MMM investment lost money… except for when the whole market was falling, and during those periods (like 2007-2009) it fell just a whisper less than the overall market.

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So that’s a long way of telling you what you already know: 3M is a great company and a “blue chip” stock, it pays a decent dividend that’s a little above average and increases every year, and, like most of its “blue chip” peers in this income-starved low-rate world, it’s got a pretty rich (but certainly not absurd) valuation. Sound like the kind of “boring” stock you’d like to build your portfolio around? Let us know with a comment below.


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