Earlier this week I wrote about my process of doing a quick initial company review to get an idea of whether I might be interested in adding a company to my watch list or not.  I used 4 companies to show as examples and one of those companies that I wanted to do a more in depth analysis of was 3M Company (MMM).

3M Company is a diversified manufacturer and technology company that operates in over 65 countries.  3M operates in 6 different segments: Industrial and Transportation, Health Care, Consumer and Office, Safety Security & Protection, Display & Graphics, and Electro & Communications.

As an investor, I like the idea that 3M operates in 6 different segments because it gives an extra element of safety to the company through diversification.  My initial review of a company involves reviewing the 10 year earnings per share (EPS) trend.  3M caught my attention because this trend has been up over the past decade every year except two.

3M has a 56 year long dividend growth streak.  This puts 3M in an exclusive group of companies I refer to as the Kings of Dividend Growth with an exceptional five plus decade long streak of annual dividend increases.

Dividend Growth and Current Yield

3M Company currently pays a dividend of $0.855 per quarter for a $3.42 annual dividend.  At the close of market on Wednesday January 8th, MMM’s price per share was $136.63.  This gives the stock a current dividend yield of 2.50% (3.42/136.63).

In 2003, 3M Company payed an annualized dividend amount of $1.32 per share.  The dividend trend has been up each year as it now pays $3.42 annually per share.  This gives MMM a 10 year annual compound dividend growth rate of 9.99%.  More recently the annual dividend growth rate was 7.28% for 2011 to 2012 and 34.65% for their most recent dividend increase.  These dividend growth rates should please the owner of 3M Company.  For a company with an over five decade long dividend growth streak, I’d be pretty pleased that they are able to continue to grow the dividend rate at a near 10% clip.

Earnings Per Share Growth

3M had a 2002 earnings per share (EPS) of $2.50 and a 2012 EPS of $6.32.  Over the 10 years their earnings per share have been consistently climbing upward with just two down years coming during the great recession back in 2008 and 2009.  3M has had a 10 year EPS growth rate of 9.72% which is an excellent growth rate for such a large established company.

More recently 3M’s annual EPS growth rate was 6.04% from 2011 to 2012 which is a satisfactory growth rate for such an established company.  Going forward, Value Line Investment Surveys has projected earnings growth of 7.5%.

Net Income Growth

3M Company has been consistently growing net profits since 2003.  MMM has a 9 year net profits growth rate of 7.07%.  Most recently 3M has increased net profits by 3.76% in 2012.  Over the past decade, 3M Company has been able to almost double their total net profits for shareholders.  While there are certainly many companies that are growing profits at a higher rate than 3M, for such an established company this is a pretty acceptable growth rate.

Sales Growth

Sales have also been trending upward for 3M over the past decade.  The compound annual growth rate of sales revenues was 5.65%.  It appears that 3M company has been able to growth EPS and net profits at a slightly higher rate than total revenues.  Companies can achieve this type of result by increasing profit margins, lowering expenses and reducing the outstanding share count.

Outstanding Shares

Generally I like to see a decreasing trend or at least a consistent balance in the number of outstanding shares of the company.  3M Company has decreased outstanding shares over the past decade by about 12%.  Along with dividends, 3M has been increasing shareholder value through stock repurchases although it appears the majority of that decrease in outstanding shares came before 2007.

With less shares outstanding, the value of each share still available increases.  When a company decreases the number of shares available it means the shares I own will have rights to a greater portion of the companies profits.  I like seeing that management has shown a commitment of purchasing back shares and increasing current owners percentage of the company.  Along with dividends, a decreasing share count is a way for management to return value to shareholders.

Current Ratio

Current ratio measures a companies ability to meet short term obligations.  3M has a 2012 FYE current ratio of 2.2.  This means that current assets will be able to cover just over double current liability obligations.  I generally want to see this number be above 1.  I don’t believe 3M should have any trouble covering short term obligations.

Net Profit to Long Term Debt

This number tells me how many years worth of profits it will take to pay off the current long term debt of the company.  I like looking at this metric because it gives me an idea of whether the company has taken on too much debt or not.

Generally I look for this number to be less then 5 meaning if the company used all their earnings over the next 5 years they could wipe out all debt.

For 3M Company, this net profit to long term debt ratio stands at about 1.1 for 2012.  This means that 3M would be able to pay off all their long term debt with a little over one years worth of net income.  In my opinion 3M has a pretty strong balance sheet and is a very safe company with not too much debt.  In fact, Value Line gives 3M Company an A++ for financial strength.

Dividend Payout Ratio

The dividend payout ratio measures the dividend per share compared to the earnings per share.  How much of a companies earnings per share are they paying out to shareholders in the form of a dividend.

The past few years MMM has maintained a dividend payout ratio around 37%.  This tells me that 3M is paying out around a third of their profits back to shareholders and using the remaining profits to continue to grow the company and buy back shares which they have had success doing over the past decade.  I like the lower payout ratio because it tells me that the company has room to expand the current dividend rate and should be able to pay dividends in the future with little trouble even if economic conditions turn negative.  This benefited 3M during the most recent recession as they were able to continue their dividend growth streak despite slight decreases in profits.

Price/Earnings Ratio

The P/E ratio is a metric I look at to determine if a companies current stock price is too high or within reason.  With the most recent closing market price of $136.63 and most recent EPS of $6.32, MMM has a current P/E right around 21.6.  Typically the market P/E average is right around 14 so compared to the market in whole I might determine 3M to be overvalued.

Looking at MMM’s past P/E ratios, the average P/E ratio for 3M’s stock over the past decade was 16.5.  The current P/E of 21.6 is higher than the past average P/E ratios.  This might lead me to believe that 3M is slightly overvalued.  Before the recession, 3M typically traded at a higher P/E ratio more in line with where it trades.  Since the recession it has traded around 15 before this year where the company has had a very large increase in price.

Return Projections

3M had EPS of $6.32 in 2012.   The past earnings per share growth rate has been roughly around 9.72%.  However, we calculated a much lower growth rate in sales revenues for 3M.  Therefore I am going to use an EPS growth rate of 7.5% over the next 11 years to figure out what 2023 EPS might look like.  This gives me an estimated EPS of $14.00 for 3M in 2023.

If 3M is trading at reasonable P/E ratio compared to their history of 17 in 2023 then it will have a market price of $238/share (14*17).  This will give me an estimated annual growth rate for 3M of 5.71% over the next 10 years.  If you would be happy earning a 5.71% return over the next few years along with collecting annually increasing dividend payments, then 3M might be an investment worth considering.

This is a very rough exercise based on growth estimates that may not come to reality.  Actual returns in MMM will vary depending on how well the company increases their earnings and how the market values 3M Company in the future.

Recommendation

After my initial review of 3M, I was very interested in doing a further in depth analysis of the company.  After this more in depth analysis, I’m still fairly excited about an investment in the company sometime in the future.  However, based on 3M’s current valuation, I believe investors may be better off waiting for a slightly better entry point.  3M has had a large run up in price of near 50% over the past year and currently trades near its 52 week high.  The recent high run up of price has brought the company’s valuation compared to earnings over 21 P/E.  Normally I prefer to buy companies when trading at a P/E under 20.

3M is a large conglomerate company that operates in 6 different segments.  This earnings diversification along with the 56 year dividend growth streak and the strong balance sheet makes me very interested in 3M.  Even though the company isn’t growing earnings at spectacular rates, they still offer decent growth with quite a bit of safety.

If 3M were trading at a current P/E under 20 I would probably consider purchasing some shares in this company.  A purchase of 3M would add a strong safer company to my portfolio providing me with more diversification.  This makes it worth buying the company despite the lower growth rates.  I just want to wait for a lower entry point.

Do you have an opinion on 3M Company?  Please share your thoughts in the comments below!

Disclosure:  I do not own an shares of 3M Company.

If you are interested in learning more about the process of analyzing dividend growth companies, then be sure to sign up for more information on my new project Dividend Growth Academy.  I am currently working on creating the Academy to help teach others interested in dividend growth investing.

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