Recent Buy (8)
Purchases for my FI Portfolio have been few and far between the last few years. That's not for lack of opportunities or desire rather it had to do with our lives being on a roller coaster. However, there's a light at the end of the tunnel as our main goal for this year is to get rid of all non-mortgage debt and then refocus our energy towards building up the portfolio.
We aren't contributing fresh capital to our investments just yet as we're focused on getting rid of our non-mortgage debt. However, that doesn't mean that we're not able to make new purchases thanks to the dividends that keep rolling in from our other positions.
One of my goals for my FI Portfolio in 2019 is to build up the positions rather than build out the number of positions. Essentially I want to get more exposure to the companies that I own instead of many small positions that make it hard to be motivated to monitor the company. With the dividend growth strategy I still think it's fine since the bulk of the work should be done upfront; however, why invest more capital into your 20th or 30th best idea if one of the top 10 is attractively valued? So that's just what I did.
Armed with some cash from trimming my position in McDonald's (MCD), I was ready to get that capital working for me once again. I already added to my position in Altria (MO) and saw another great company trading at a fair price.
On July 1st I purchased an additional 7 shares of 3M Company (MMM) at $174.35 per share. The total cost basis, including commissions, for this lot came to $1,225.40 or $175.06 per share.
3M Company is a Dividend Champion with 61 consecutive years of dividend growth. Based on the current quarterly payout of $1.44 per share the YOC for this slug of shares is 3.29% and I can expect to receive $40.32 in dividends over the next year barring any future increases from the new shares.
I now own 25 shares of 3M at an average per share cost basis of $153.67. My entire position in 3M can be expected to produce $144 in dividends over the next year and carries a YOC of 3.75%.
Due to this purchase my FI Portfolio's forward 12-month dividends increased to $7,066.92.
As a dividend growth investor any potential investment must Jerry Maguire me, i.e. "SHOW ME THE MONEEEEEEYYYY!!!!". I judge that based on a company's history of both paying and growing dividends to shareholders. With a 61 year streak of rising dividends I'd say that 3M definitely qualifies.
For an industrial business like 3M, I fully expect their dividend growth to fluctuate more than say a consumer staple company. As such I prefer to look at dividend growth over longer periods like 5-10 years to get an idea of how it might look over the entirety of the business/economic cycle. You can see those year to year fluctuations in the following chart and how the 10-year dividend growth rate, green line, is much smoother.
The 1-, 3-, 5- and 10-year rolling dividend growth rates since 1977 can be found in the chart below.
One valuation method that I like to use is dividend yield theory. The idea behind dividend yield theory is that large, stable companies will see their dividend yields revert to their mean over time. So when the yield is higher than "average", shares are undervalued and when it's lower than "average", shares are overvalued.
Dating back to 2000, 3M's dividend yield has been relatively consistent in the 2-3% range for the bulk of that period. The yield at my purchase, 3.29%, is significantly higher than the 5 year moving average of 2.56%. Based on dividend yield theory shares of 3M the fair value of 3M would be up at $225 per share suggesting ~28% upside at the current prices.
As another quick valuation check, 3M's 5 year average P/E ratio is 23.1x according to Morningstar. Analysts expect 3M to show earnings of $9.43 for FY 2019 and $10.33 for FY 2020. That puts the forward P/E ratios at 18.6x and 16.9x, respectively.
Of course here's where some discretion needs to come in. On average analysts are expecting earnings growth of just 3.7% per year over the next 5 years. So the undervaluation we see from dividend yield theory could be the market adjusting the yield higher to reflect lower growth. With a forecast of 3.7% earnings growth added to the 3.29% current yield that puts the forecast annualized returns at roughly 7% per year.
Currently I believe 3M is closer to the great company at a fair price range rather than at a deep discount to its intrinsic value. But with a starting yield around 3.3% you're getting paid a relatively strong dividend yield while you wait for 3M to get growth moving forward again at a faster pace.
We're still several months away from being able to get back to regular monthly investing so this small purchase that I made using the proceeds from my position trim felt good. I love being able to invest capital and look for new ideas that offer better value prospects. As a dividend growth investor there's not much better, at least investing wise, than being able to put your money to work and see those forward dividends rise.
One of the great things about the "swap" I've done between McDonald's and subsequently purchasing shares of both Altria and 3M is that my forward dividends have increased rather nicely despite not putting all of the capital back to work. I've recovered 104% of the "lost" dividends while only deploying 47% of the proceeds from the sale.
I've started compiling the dividend history, growth rates and dividend yield theory for many dividend growth companies. 3M's can be found here and the remaining companies that I've already gathered the data on can be found here. As new companies are added the list will be updated.
What do you think of my purchase of 3M? High quality at a fair price or is it pushing into undervalued territory?