Every Investor Should Consider Owning This “Forever” Stock
Investors can very easily get caught up in quarterly earnings reports, rejoicing when their stocks report good results and second-guessing their picks when things go awry. It’s important to remember, though, that investing is a long-term endeavor and that quarterly outcomes are far less important than how a stock performs for longer periods — several years, five years, a decade… and beyond.
Companies that persevere and nicely reward shareholders for many decades are known at StreetAuthority as “Forever Stocks.” Sure, these stocks may have their ups and downs, but in my experience, Forever Stocks are usually worth holding, well, forever.
You know 3M, the $61 billion diversified industrial firm that was founded in 1902 and is now famous for its innovations such as Post-It Notes and Scotch Tape. The company’s product portfolio includes a wide range of other items, from liquid crystal display (LCD) films, car care products and dental equipment, to adhesives, shampoo and sandpaper.
The firm did have some setbacks in the fourth quarter of 2011, particularly in its display and graphics business, where sales fell 9% from $904 million in 2010 to $823 million. The electro and communications segment did poorly, too, as shown by a 3% decline in revenue from $792 million seen in 2010 to $768 million. Earnings per share (EPS) for 2011 came in at $5.96, a mere 3.7% increase from EPS of $5.75 in the previous year.
But it’s important for investors to put such short-term disappointments out of their minds and focus on what makes 3M a Forever Stock. First of all, there’s long-term performance. The stock returned 457% during the past 25 years, which translates to a solid 7% a year.
Plus, as a firm that has increased its dividend 53 straight years (it currently yields 2.5%) and typically holds lots of cash (about $3.8 billion currently), 3M is likely to maintain or even increase its yield in the future. After posting a solid dividend growth rate of 6.5% annually for the past five years, analysts say 3M should be able to push up its dividend at an even faster 10% pace for the next three to five years, bringing it from $2.20 per share in 2011 to $3.54 a share in 2016, good for a 4% yield at today’s prices.
Such gains are feasible because 3M is expected to nearly double its annual EPS growth rate, from 6.5% during the past five years to 12% for the next three to five years. This sort of improvement is possible because of 3M’s excellent balance sheet: it sports well below-average debt, as shown by a debt-to-equity ratio of 0.3 compared with the industry average of 0.7. In addition, superior financial strength should let 3M easily add some new debt to pay for promising acquisitions — a strategy management is already pursuing.
On Sept. 26, 2011, for instance, 3M issued $1 billion of five-year bonds with a coupon of 1.375%, and on Jan. 3 it announced the acquisition of the office and consumer products division of Avery Dennison Corp. (NYSE: AVY) for $550 million. This division — which boasts an array of office products like dividers, labels and binders — and had $765 million in sales last year, should nicely complement 3M’s Post-It and Scotch brands. Management expects the new division to begin paying off quickly, boosting EPS by $0.03 a share once the deal closes in the middle of 2012.
In addition to making profitable acquisitions, I’m confident 3M will continue its long tradition of innovations that bolster the bottom line. In the near-term, innovations may emerge mainly as improvements to existing products and production processes rather than the introduction of a single new blockbuster product like Post-It notes. In March 2010, for example, CEO George Buckley responded to cost-cutting pressure by asking employees to come up with ways to make production of the company’s low-cost, high-performance respirator mask four times faster. 3M hasn’t specifically publicized the results of this initiative, though I suspect it was successful. That’s because it wouldn’t be out of the ordinary for 3M. It’s what helped earnings per share (EPS) spike more than 27% between 2009 and 2010, from $4.52 to $5.75 a share, as cost-cutting efforts throughout the company helped boost the bottom line.
But investors shouldn’t dismiss the possibility of more of the “sexier” innovations 3M is known for, either. The Kind Removal silicone medical tape introduced in June 2011, for instance, is designed so it can be removed as gently as possible from patients’ skin, and was named by Popular Science as one of the top 100 most innovative ideas of 2011.
Risks to Consider: CEO Buckley turns 65 on Feb. 23, and he and 3M must agree to extend his contract on that date. Buckley will be at the age when 3M CEOs typically retire, so it’s possible he could depart and introduce an element of uncertainty about the company’s future, to which the market may not respond well.
Action to Take –> Still, investors shouldn’t worry about Buckley departing. 3M was a Forever Stock when he arrived in 2005 and it’ll likely continue to be one well after he’s gone. At about $87 a share, the stock’s a good value. It’s worth almost $96 a share when you consider investors have historically paid 4.2 times book value, which is currently $22.82 a share. If you multiply $22.82 by 4.2, you get a share price of $95.84 — and that’s the only price you’d pay for the company’s assets, so it would be sort of like getting the dividend for free. It can’t get better than this.
[Note: If you're wondering who coined the term "Forever Stock," that would be none other than StreetAuthority co-Founder Paul Tracy. He's put together a special report, called "Top 10 Stocks to Hold Forever," in which he describes what makes a stock worth holding forever and gives the names of some of his favorites. Go here to learn more.]
– Tim BeganySource: StreetAuthority
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