"But how, you will ask, does one decide what [stocks are] "attractive"? Most analysts feel they must choose between two approaches customarily thought to be in opposition: "Value" and "growth" ... We view that as fuzzy thinking ... Growth is always a component of value [and] the very term "value investing" is redundant." -- Warren Buffett, Berkshire Hathaway (BRK.B) annual report, 1993
We take Buffett's thoughts one step further. We think the best opportunities arise from a complete understanding of all investing disciplines in order to identify the most attractive stocks at any given time. We therefore analyze each stock across a wide spectrum of philosophies, from deep value through momentum investing.
This involves performing significant valuation analysis, both on a DCF and relative value basis, as well as a strong consideration of the firm's fundamentals (cash flow, risk, etc.), technicals and momentum indicators. The best stocks, we believe, will be attractive from a number of investment perspectives -- from value through momentum (hence our name, Valuentum). On the other hand, the worst stocks will be shunned by most investment disciplines and display expensive valuations and poor technicals and momentum indicators.
As part of our process, we employ a discounted cash-flow model to arrive at a fair value estimate for every company within our equity coverage universe. In 3M's (MMM) case, we think the shares fall within our estimated fair value range.
Nonetheless, our fair value estimate for the company is just over $90 per share, nearly 20% higher than where it is currently trading. In the spirit of transparency, our DCF valuation model template can be found here. We make this template available to investors, and it can be re-used to value any other operating firm in your portfolio.
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Source: Valuentum Securities, Inc.
Our discounted cash flow model indicates that 3M's shares are worth between $68.00 - $118.00 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $93 per share represents a price-to-earnings (P/E) ratio of about 16.5 times last year's earnings and an implied EV/EBITDA multiple of about 9.9 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 6.5% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 2.9%. Our model reflects a 5-year projected average operating margin of 22.1%, which is above 3M 's trailing 3-year average.
Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 2.3% for the next 15 years and 3% in perpetuity. For 3M, our model uses a 9.3% weighted average cost of capital to discount future free cash flows.
We'd consider adding 3M to our Best Ideas portfolio, if it became relatively more attractive than our existing long ideas. Readers can also take a look at our second-quarter earnings note on 3M here, if they may be interested in the firm.