Why 3M Hit an All-Time High

R&D remains a key driver of company's growth

Author's Avatar
Jul 20, 2017
Article's Main Image

3M Co. (MMM, Financial) operates in several end markets and geographies, using its scale to get lower costs than competitors. Moreover, new patents should help to achieve growth with operating margins of more than 20%.

The company was able to increase free cash flow and remain profitable. 3M has great cash generation with the adhesives and tapes segment as the biggest contributor. Free cash flow permits the company to maintain a dividend, which has increased for more than 50 years. The current dividend yield is 2.14%, which is quite good for protecting purchasing power, especially considering the consistency of dividend payments and favorable expectations regarding dividend growth and share repurchases over the next several years.

More than 10 years ago, sales in emerging markets accounted for a fifth of the company's revenue. Now it is close to 50%.

Moreover, the company is focused on research and development and growth in emerging markets. Both should contribute to organic revenue growth. Over the years, 3M has achieved economies of scale, introducing new products of high margins. R&D spending is around 5.5% to 6% of sales.

The company reported first-quarter profits of $2.16 per share, a 5.4% increase from the first quarter of 2016. Sales jumped to $7.7 billion, up 3.7% year over year. Further, operating income was $1.8 billion, which translates into a 23.1% operating margin. Operating cash flow of $1 billion contributed to paying $702 million in cash dividends and repurchased $690 million worth of shares.

We will now compare the best measure of performance for a company's management: the return on equity. The ROE is useful for comparing the profitability of a company to other companies in the same industry.

Ticker Company ROE (%)
MMM 3M 44.79
GE General Electric Co. 10.82
CSL Carlisle Companies 9.8
Industry Median 6.91

The company has a current ratio of 44.79%, which is higher than the industry median and those of General Electric Co. (GE, Financial) and Carlisle Companies (CSL). In general, analysts consider ROE ratios in the 15% to 20% range as representing attractive levels for investment, so this ROE is appealing. It is very important to understand this metric before investing and to look at the trend in ROE over time. It is great to see such a good level over so many years.

1500582457391.png

In terms of valuation, the stock sells at a trailing price-earnings (P/E) ratio of 25.73 times, trading at a premium compared to an average of 23.1 times for the industry. The ratio is close to a 10-year high of 25.78 times. To use another metric, its price-book (P/B) ratio of 11.56 times indicates a premium versus the industry average of 1.87 times and is close to a 10-year high of 11.6 times. Finally, the price-sales (P/S) ratio of 4.31 times is above the industry average of 1.27 times. The three ratios indicate the stock is relatively overvalued.

As we can see in the following chart, the stock price has an interesting upward trend over a five-year period. If you had invested $10,000 five years ago, today you could have $22,948, a 18.1% compound annual growth rate (CAGR). Further, 3M has demonstrated a pattern of positive EPS growth over the past two years.

1500582715447.png

Final comment

As outlined, the company has several growth drivers to contribute to long-term profitability. Growing across end markets as well as R&D investment are strategies to remain successful. Further, the company paid dividends without interruption for decades and has announced increased rates.

Hedge fund manager Jim Simons (Trades, Portfolio) initiated a new position in the stock with 49,244 shares. Other gurus like Chuck Royce (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2017, as well as First Eagle Investment (Trades, Portfolio), Mairs and Power (Trades, Portfolio) and Manning & Napier Advisors.

Disclosure: The author holds no position in any stocks mentioned.