NEW YORK (F.A.S.T. Graphs) -- In my most recent article, I detailed how Johnson & Johnson (JNJ) - Get Johnson & Johnson (JNJ) Report was a "great company," but perhaps only a reasonable investment at that time. It's always important to underscore the difference between a great company and a great stock. With today's commentary, I'd like to follow a similar ideology.
Jim Cramer recently called
terrific, without going into many details, on his fast-paced "Mad Money" show on
. As you could glean from the headine, I definitely believe that 3M is a terrific company, so I would like to take a closer look at the stock.
Let's work through this framework by utilizing the Fundamentals Analyzer Software Tool of F.A.S.T. Graphs (TM).
3M is a science-based company with brands such as: Post-It, Scotch, Command, Ace, Nexcare and Filtrete. In turn, they have products that represent more than
ranging in everything from medical devices, bandages and veterinary products, to filters, aerospace maintenance and fire protection. Perhaps more commonly, you know the company by its office supplies.
If we look at the Earnings and Price Correlated graph below, we can instantly see that 3M has been quite successful in offering its everyday solutions. 3M has grown operating earnings (orange line) by about 8.8% a year for the last decade and a half; moving from $2.13 a share in 1999 to today's expected EPS amount of $6.70. In addition, you can see the dividend (pink line) has been growing steadily while the overall payout ratio has actually been decreasing. Aside from a few earnings hiccups during the last two recessions, 3M has been a model of consistency.
In turn, it should be expected that the operating metrics of the company allowed for this solid earnings growth. And this is precisely what we see. For instance, gross profit margin and net profit margin have remained remarkably consistent over the last 15 years.
In addition, 3M has shown a great propensity to reward shareholders. The company has not only paid but also increased its dividend for 55 consecutive years -- that's over half a century, mind you. In the last decade, these increases have come in at a rate of about 6.6% per year and the company still pays out less than half of its earnings. Furthermore, 3M has done an excellent job of reducing common shares outstanding through its
-- going from over 800 million shares outstanding at the end of 1998 to just 683 million in the most recent quarter end.
Taken collectively -- strong operating results, consistent margins and a propensity to reward shareholders -- one would expect that an investor's performance results would mirror closely with the business results of the company. This is exactly what happened: 3M shareholders have enjoyed a compound annual return of 10%, which is slightly above the 8.8% growth rate in earnings per share. This positive difference can be explained by a consistent and increasing dividend with a relatively similar beginning and ending price-to-earnings ratio.
A hypothetical $10,000 investment in 3M on 12/31/1998 would have grown to a total value of $40,736.05, without reinvesting dividends. Said differently, 3M shareholders have enjoyed total returns that were roughly 2.5 times the value that would have been achieved by investing in the
over the same time period. Further, one would also have received about 3.2 times as much dividend income as the index.
So in viewing the "business behind the stock," we can easily tell that 3M has been a solid company over the time period given. In addition, a shareholder would have seen return results that roughly tracked the company's business results over the long-term. However, it is paramount to consider how 3M looks today and what it might look like in the future.
Below I have included the precise same Earnings and Price Correlated graph as first demonstrated. However, this time I added price (black line) and a "normal" P/E ratio (blue line). Here we see that 3M's market price previously began to deviate from its justified earnings growth; starting to become undervalued during the most recent recession and coming back to fair value as of late.
Today 3M appears slightly over-valued to fairly valued in relation to its historical earnings and relative valuation. 3M has a current P/E of 18, while over the past 15 years has commanded a normal P/E ratio of about 19.
However, the normal P/E ratio can be a bit misleading in a static graph. With the above graph, notice that 3M had a price that was much higher than a 19 P/E in the early-2000's, but recently has been priced such that its P/E is significantly less than the "normal" mark.
In observing this, F.A.S.T. Graphs has the ability to view the company in a range of anywhere from 2 to 20 years. For instance, a 6-year Earnings and Price Correlated graph demonstrates that 3M had a normal P/E of just 14.8 in the last 6 years.
A case could be made for a premium valuation; however, I believe it's prudent to concentrate on a P/E around 15 in making assumptions moving forward.
Eighteen leading analysts reporting to Standard & Poor's Capital IQ come to a consensus 5-year annual estimated return growth rate for 3M of 11%. A
provides a similar range of estimates.
In addition, 3M's current P/E of 18 is at the very top of the "value corridor" (defined by the orange lines). If the earnings materialize as forecast, 3M's valuation would be $168.28 at the end of 2018, which would be a 9.1% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.
Now it's paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company.
In other words, depending on what you believe might be a reasonable valuation multiple, the performance results of 3M could trail the business results of the company moving forward. That is, in viewing the past history and future prospects of 3M, we have learned that it has been a terrific company, but presently is perhaps just a good stock. However, as always, I recommend that the reader conduct his or her own thorough due diligence.
At the time of publication, Carnevale was long JNJ.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Charles (Chuck) C. Carnevale is the creator of
Chuck has over 43 years of financial experience and is the co-founder of the earnings and price correlated, powerful fundamentals analyzer software tool - FAST Graphs. Chuck holds a Bachelor of Science in Economics and Finance from the University of Tampa. Chuck's work stressing sound valuation has been widely published on numerous financial sites and blogs. Chuck is passionate about spreading the critical message of valuation and prudence in fundamental investing. So much so that regular readers have dubbed him "Mr. Valuation". Chuck is a Veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.
Chuck believes that correctly assessing fair value is one of the primary keys of successful stock investing, and he has dedicated his more than 40 years of experience in finance to its pursuit. Chuck agrees with legendary investors such as Warren Buffett, who recognize how important it is for investors in common stocks to possess an intelligent framework for making sound decisions that can keep emotions out of the equation. With making smart stock selections, there is no room for fear and greed.
Chuck was fortunate to learn at an early age that earnings drive long-term stock prices, and that dividends, if any, will be paid out of a company's earnings. This led him to develop FAST Graphs, the fundamentals analyzer software tool that reveals the long-term relationship between a company's earnings and its stock price and dividends over time. Chuck is most interested in the business behind the stock.