Is 3M The Perfect Income Stock?

| About: 3M Company (MMM)

Summary

3M has historically had extremely strong, stable and growing free cash flow.

Free cash flow margins are exceptionally high which makes it possible to pay bigger dividend than normally.

Stagnating top line growth is currently a headwind.

3M (MMM) is one of the best stocks you can have in your portfolio. It is a typical core holding which you can hold for decades because of its defensive business model.

The reason why I like 3M is because the company passes a long list of my personal strict screening criteria. I quite often divide this screening process into two simple steps. In the first step I evaluate various quantitative metrics. This is simply because the best companies out there with strong and wide moats usually have strong financial metrics. If a company can charge 10% more than its competitors, it clearly needs to do something better than the rest. These type of companies are usually the ones who are able to survive even the most difficult business environments and still continue rewarding their shareholders. In the second step, I continue applying a few qualitative factors on the companies which have passed my first step.

In this article, I will be showing what type of quantitative metrics I applied to 3M. I will not be considering the current or historical valuation of the shares. That will be left for the reader. 3M is a company founded in 1902 which is a true conglomerate as it manufactures for instance adhesives, medical products, car shampoo and so on. I have for some time had my eye on the company's shares but I have not done my due diligence until now.

Let's start the analysis by looking at free cash flow. From historical point of view, free cash flow has been growing at an annual rate of 6.9% and 8.1% during the last decade and two decades. These figures can be considered rather decent. In addition, in the case of 3M, it is very easy to assess near term cash flows. The below graph clearly summarizes why 3M has been such a profitable investment.

Source: author generated using SEC filings

The long-term dividend history seems to be good with an annual growth of 9.1% and 7.9% for the last 10 and 20 years. The dividend growth is supported by the increasing free cash flow as can be seen further above from the free cash flow graph.

Source: author generated using SEC filings

Irrespective of good historical dividend growth, more important is the future growth potential. Historically, free cash flow has been able to cover dividend payments well.

Source: author generated using SEC filings

Especially during the current zero interest rate environment where money is almost free, many corporations are relying on it for the wrong reasons, such as share buybacks (in some cases) or excessive acquisitions. Therefore I find it important to look at how free cash flow has historically covered existing debt. In the case of 3M, free cash flow has covered debt very well.

Source: author generated using SEC filings

Sales are probably one of the most important metrics in a financial statement. This is simply because without increasing revenue, there is no possibility for a company to grow its dividends. As you can see below, top line has been growing at an annual rate of 2.7% and 3.8% for the last 10 and 20 years, which is rather weak.

Source: author generated using SEC filings

How has free cash flow relative to sales developed through the years with 3M? For the last 10 years it has been on average 14.5% and for the last 20 years 13.1%. Those values sound exceptional.

Source: author generated using SEC filings

Return on assets is probably one of the best metrics when calculating profitability. This is simply because it takes into consideration all physical and intangible assets. Intangibles are often generated through major acquisitions so it is advisable to assess how profitable they have been. After all, it is rather simple to pay too much. In the case of 3M, return on assets using free cash flow has been on average 13.5% and 12.9% for the last 10 and 20 years. Those values are exceptional.

Source: author generated using SEC filings

When it comes to return on equity using free cash flow, it has been around 31.7% and 29.6% for the last 10 and 20 years. Those values are really good.

Source: author generated using SEC filings

The most common ways to distribute profits to shareholders are via dividends and share buybacks. Lets next look at how has the company managed its share capital in recent years. In the case of 3M, per share figures are even better as share buybacks have decreased the amount of shares annually by around -2.0% and -1.6% for the last 10 and 20 years.

Source: author generated using SEC filings

Personally I prefer investing in companies that have low capital expenditure requirements and that require little capital for growth. 3M has been using on average 4.8% from sales to capital expenditures during the last 10 years. For the last 20 years the same figure stands at 5.4%. These figures are modest.

Source: author generated using SEC filings

Summary
There's not anything bad to say about 3M's financials as they look almost too perfect. Therefore, I would say 3M is a perfect candidate for any portfolio. The margins from the RoS, RoE and RoA point of view clearly indicate that 3M has a strong competitive advantage over its competitors. In addition, capital expenditure requirements seem rather modest and debt load seems to be extremely well under control.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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