In this article, let's take a look at 3M Company (MMM), a $90.04 billion market cap, diversified global company that operates as a diversified technology company with manufacturing operations in around 70 countries worldwide. I was impressed how the company survived the last U.S. recession, reducing working capital to increase free cash flow and remaining profitable.
R&D
R&D is a strong competitive advantage because 3M focuses on the introduction of new products at high margins. Every year the company spent between 5.5% and 6% of sales to R&D. Unlike its competitors, the firm operates in different end markets and geographies, where it uses its scale and distribution channels to achieve lower costs than it peers. The firm permits that its engineers can dedicate certain time to their individual pursuits, searching for patents and new ideas, which could help internally driven growth.
The idea of constantly trying to refresh its product portfolio, has impacted revenue growth, which was higher than global GDP. Also, in the past ten years, it has achieved returns better than its cost of capital with adequate operating margins about 20%.
Last, we may not forget that 3M has the cash generation machine which one of the best in the diversified industrial peer group.
Well diversified
The diversification across product and markets offset any specific poor result. The largest contributor to revenue is "adhesives and tapes" within the industrial segment, which makes up 10.5% of consolidated revenue, followed by the automotive and aftermarket business which contributes with 9.5% of revenues. The other 27 business lines make up the residual.
Excellent track record
3M has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends as it has increased its dividend for 56 consecutive years. The current dividend yield is 2.3%, which is quite good, to protect the purchasing power, especially considering the consistency of track-record dividends payments and favorable expectations regarding dividend growth and share repurchases for the next years. The company recently announced a plan to return cash to shareholders through accelerated repurchases and dividends, increasing the payout ratio to diversified industrial peers.
Revenues, margins and profitability
Looking at profitability, the revenue growth (4.92%) has outpaced the industry average. Earnings per share increased by 11.2% in the most recent quarter compared to the same quarter a year ago ($1.91 vs $1.71). During the past fiscal year, the company increased its bottom line. It earned $6.72 versus $6.31 in the previous year. This year, Wall Street expects an improvement in earnings ($7.45 versus $6.72).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| MMM | 3M | 27.32 |
| GE | General Electric Co. | 10.16 |
| JNJ | Johnson & Johnson | 28.23 |
| Industry Median | 7.63 |
The company has a current ratio of 27.32% which is higher than the industry median and the one exhibited by General Electric Co. (GE). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment, so this ROE looks very attractive. So for investors looking at those levels, Johnson & Johnson (JNJ) could be the option. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time. It is great to see such a good level during so many years.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 19.6x, trading at a discount compared to an average of 22.1x for the industry. To use another metric, its price-to-book ratio of 5.24x indicates a premium versus the industry average of 1.7x while the price-to-sales ratio of 2.99x is above the industry average of 0.97x. That P/E indicates that the stock is relatively undervalued and seems to be an attractive investment relative to its peers.
As we can see in the next chart, the stock price has an interesting upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $20,292, that is a 15.2% compound annual growth rate (CAGR). Further, 3M has demonstrated a pattern of positive earnings per share growth over the past two years.
Final comment
As outlined in the article, several growth catalysts make me feel bullish on this stock because I think 3M will successfully integrate acquisitions and continue to make innovations, while diversifying across end markets. Further, efforts in R&D should help improve its product vitality, pricing and longer-term profitability.
Valuation is another key reason in considering 3M as an investment. So in this opportunity, I would recommend fundamental investors to consider this attractive option for their long-term portfolios.
Hedge fund gurus like Ray Dalio (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Jean-Marie Eveillard (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2014, as well as Diamond Hill Capital (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).
Disclosure: Omar Venerio holds no position in any stocks mentioned
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