With another earnings season in high gear, here are two ways investors can use companies’ reports to justify share purchases:
- If a presentation is disappointing – earnings are down, revenue is falling, margins are squeezed – or even if a report is decent but not quite as solid as analysts expected, sellers probably will drive down the price.
- If a report excels – numbers exceed expectations, and the company’s forward guidance suggests that the good times will continue to roll – enthusiasm will push the price higher.
During my years of investing, I have bought stocks in each situation.
Meanwhile, Scenario 2 – sometimes referred to as “a beat and a raise” – signals that a company’s financial strength could power it to continued heights.
So even though Mr. Market might not put that stock “on sale,” I still might be a willing buyer.
It is the latter situation that has driven me to the company that will be Position #2 for DTA’s Income Builder Portfolio:
3M (MMM)
Come next Tuesday, Jan. 30, I will buy about $1,000 worth of the industrial conglomerate for the real-time, real-money Dividend Growth Investing portfolio we are building from scratch.
I already had been a long-time admirer of this Dividend King (50+ consecutive years of annual dividend growth), and the stellar earnings report 3M filed on Thursday, Jan. 25, gave me another reason to be a fan.
Another reason? Actually, MMM’s report provided several reasons to be excited:
- 2017 full-year sales of $31.7 billion, up 5.1%.
- 4th Quarter sales of $8 billion, up 9% year-over-year and $110 million more than analyst estimates.
- 2017 full-year earnings per share of $9.17 (excluding net impact of the tax-cut), up 12.4%.
- 4th Quarter EPS of $2.10 (excluding tax-cut impact), up 11.7% and .07 better than analyst estimates.
- Organic growth in all business groups and all geographic areas, over both Q4 and the year overall.
- Raised 2018 organic local-currency sales growth guidance 3% to 5%.
- Returned $4.9 billion to shareholders via dividends and gross share repurchases in 2017.
- Raised 2018 full-year earnings outlook: EPS of $10.20 to $10.70, vs. $9.60 to $10 previously.
One thing I really like about 3M’s growth is how broad-based it is. Every segment of the company did well, as this slide from Thursday’s presentation shows:
As great as it is to get all the good news about what took place in 2017, it is the guidance about what the company expects – an even better 2018 – that has me ready to add MMM to the IBP.
The above FAST Graphs illustration of 3M’s earnings shows the consistent EPS growth (orange line). There were only two small blips (red circles) – a 7% decline during the dot-com bust in 2001, and a 9% decline during the Great Recession in 2009. In both cases, MMM’s earnings not only rallied but did so strongly (green circles), with gains of 21% and 23%, respectively.
The blue arrow and circle indicate that future earnings are expected to move higher. And the numbers highlighted in yellow show that FAST Graphs has not yet updated the illustration to reflect announced 2017 EPS of $9.17 or projected 2018 EPS of $10.20 to $10.70.
Like other more, um, “experienced” people, I remember the old TV commercials in which the pitchman told viewers all about the wonderful deal for the wonderful product – only to pause for a moment before shouting, “But wait … there’s more!”
That’s kind of how I feel as I get ready to relay one more piece of incredible news that 3M handed investors on earnings day. Here’s CEO Inge Thulin:
… For more than a century, the strings of 3M business model has enabled us to invest in the business while also returning cash to our shareholders; this has included a strong, steady and rising dividend, which is a hallmark of our enterprise. … Today we are announcing a 16% increase in our first quarter dividend for 2018 to $1.36 per share. This marks 60 consecutive years of dividend increases and reflects confidence in our ability to continue generating premium returns in 2018 and beyond.
That’s right, DGI fans: a 16% dividend hike, lifting the annual payout to $5.44.
At Friday’s closing price of $258.63, that is a yield of 2.1%.
How special is 3M’s dividend-growth streak of 60 years? According to the list of Dividend Champions compiled by my friend and DTA colleague David Fish, here’s how special:
When Dave updates his Champions spreadsheet on Feb. 1, MMM will be one of only 8 companies in the world with such a streak.
While some companies high up on this list have been giving token increases just to keep their runs alive, 3M has MORE THAN DOUBLED its dividend in the last 5 years. It paid $2.54 annually in 2013.
And even with all of this growth, MMM’s dividend has been graded as extremely safe on Simply Safe Dividends’ 1-to-100 scale.
In giving MMM a “Buy” rating, McLean Capital Management shows how the company’s free cash flow consistently covers its dividend.
I have spent so much time sharing so much good financial news that I haven’t even talked about what 3M does yet.
The short answer: A freakin’ lot!
As demonstrated by this just-snapped photo of my actual home office – featuring a workspace littered with brightly colored little sheets – I couldn’t function without 3M’s most famous product!
But 3M is about so much more than Post-it notes. Its business was reorganized back in 2013, and it is spread over 5 segments:
- Industrial: tapes; coated and non-woven abrasives; adhesives; specialty materials and filtration products used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles.
- Safety and Graphics: architectural markets; building and commercial services; commercial graphics; industrial mineral products; personal safety and security.
- Electronics and Energy: communication markets; electronics markets materials; infrastructure protection; optical systems; renewable energy; 3M Touch Systems.
- Health Care: medical and surgical supplies; skin health and infection prevention products; drug delivery systems; dental and orthodontic products; health information systems; anti-microbial solutions.
- Consumer: office supply products; stationery products; construction and home improvement products; protective material products; consumer health-care products.
Among the most recognizable names in its product line:
Morningstar said 3M has a “wide moat” – an economic advantage over its competitors. In giving Thulin and the rest of MMM’s management team its highest stewardship grade – “exemplary” – Morningstar analysts said this:
Thulin revised his ambitious five-year plan in 2016 after only three years in, factoring in the recent challenges of a slower-growing global economy. We recognize the importance of pivoting when the economic environment changes. As such, we still view portfolio management as one of the company’s strengths, and we believe newly set 2020 targets are achievable.
Is There A Downside?
Just as no investor is perfect, no stock is perfect.
The main cautionary note I present about 3M is that it is in a cyclical industry. As such, its share price can be influenced significantly by the ups and downs of the overall economy.
As the following snippet using the DividendChannel.com calculator shows, MMM dropped pretty much in lockstep with the S&P 500 Index (SPY) during the Great Recession:
Declines greater than 50% are never fun, so investors who are prone to panic in such falling-economy situations might be wise to steer clear of any cyclical company.
Nevertheless, for those who kept their MMM shares through the recession (as I was fortunate enough to do), the recovery was swifter and stronger than it was for the overall market. And although the company increased the dividend at a lesser rate (a range of 2% to 4%) during the last two recessions, it did still grow those payouts.
Thanks in part to reinvesting dividends at bargain prices, a $10,000 investment in 3M on Oct. 1, 2007, would have gotten back into the black by Aug. 4, 2010; a similar SPY position would have still been well in the red.
Morningstar outlined a few other potential concerns:
3M’s decision to add more debt to its balance sheet in pursuit of an optimal capital structure coincided with a recent appetite for acquisitions of larger companies; as such, there is the potential that 3M could be tempted to overpay for growth.
From a macroeconomc perspective, as 3M works to increase exposure to emerging markets, currency risk heightens. This dynamic could cause revenue and profitability to fluctuate more materially across the business cycle. Although 3M’s diversified portfolio shields it from many geography-specific economic challenges, the possibility of a reinvigorated global slowdown or U.S. recession presents substantial risk to the company’s near-term growth, and overlapping regional downturns could cause the entire portfolio to experience merely middling growth in the longer term due to diversification.
Wrapping Things Up
Because I believe the benefits far outweigh the risks, 3M will follow Amgen (AMGN) as Position #2 in the Income Builder Portfolio.
My article about the execution of our MMM purchase, along with some pertinent valuation information, will be published Wednesday, Jan. 31.
I am not a financial advisor, and this is not a recommendation to buy any stock. Each investor should conduct his or her own due diligence.
— Mike Nadel
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Disclosure: I own MMM in my personal portfolio.