Recent Buy (12)
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 and some sales that we've made. Although I'm hopeful to start making at least one regular purchase each month starting in September!
One of my goals for my FI Portfolio for 2019 is to build up the positions rather than build out the number of positions. Essentially I want to increase my exposure to the companies that I own instead of many smaller 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 is done upfront; however, I still think that in general the less the better.
With August getting off to a bit of a rocky start, I took advantage of some of the weakness and added to my position in 3M Company (MMM). On August 15th I purchased an additional 7 shares of 3M for $157.50 per share. The total cost basis, including commissions, for this lot came to $1,107.45 or $158.21 per share.
3M 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 3.64% and I can expect to receive $40.32 in dividends over the next year barring any future increases.
I now own 32 shares of 3M after first initiating a position in August 2014. The average per share cost basis for my 3M position is $154.66 and the entire position carries a YOC of 3.72%. My 3M position can be expected to produce $184.32 in annual dividends.
Due to this purchase my FI Portfolio's forward 12-month dividends increased to $7,276.03.
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. 3M's 61 year streak is bested by just a handful of companies.
3M's dividend growth for any given year has seen wild fluctuations. Over every 1 year period since 1977 annual dividend growth has ranged from 1.8% to 34.7% with some very obvious waves likely due to the business cycle.
For businesses with a larger variation in year to year growth I prefer to look at 10-year annualized dividend growth rates to see what could potentially be in store over the longer term and throughout a business cycle.
Of the 33 rolling 10-year periods since 1977 3M's annualized dividend growth has ranged from 4.4% to 10.9%. The average annualized dividend growth rate has come in at 7.2% with a median of 7.2%. That's how long term wealth creation can be built through dividend growth investing especially when you consider that the initial dividend yield for shares of 3M has been in the 2-4% range.
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.
As you can see in the above graph, shares of 3M haven't offered a dividend yield this high since the 2007/09 period and before that it was the mid 1990's since shares yielded this much. The YOC for these shares of 3.64% is in the 97th percentile dating back to 1990.
The current 5-year moving average dividend yield sits at 2.58%. In order for 3M to offer that dividend yield the share price would have to rise to $223 or roughly 40% from my purchase price. Even a return to just 3% suggests approximately 21% upside potential.
Based on a quick and dirty Gordon Growth Model calculation 3M needs to grow the dividend at 6.14% per year in order to generate 10% annual returns.
When looking at valuation multiples things look pretty good as well. Based on my purchase price of $158.21 the TTM P/E ratio sits at 19.1x. Based on current year, FY 2019, estimates the P/E ratio is 16.8x and on FY 2020's estimates it's 15.6x.
I've also started looking at multiples using enterprise value. The reason I like using enterprise value is that it encapsulates purchasing the entire business, both the equity and the debt net of cash. Using EV/EBIT, Joel Greenblatt's Magic Formula valuation metric, 3M is trading at a 16.4x EV/EBIT multiple or a 6.1% EBIT yield. Looking at EV/EBITDA it's 13.4x or 7.5% EBITDA yield.
My preferred EV multiple is the EV/FCF. 3M is a bit expensive here at 19.8x or a 5.0% FCF yield; however, it's not exorbitantly so.
The last time that I did a full analysis on 3M was in January 2017, so it's probably time to update that. At that time I pegged a fair value price for 3M around the $160 level. With another 2 years of growth behind it I would guess the fair value estimate would bump up to around the $185-190 level implying my purchase price having roughly 17-20% upside potential.
I'm sure much of the discount to fair value is due to the fact that 3M is only expected to grow earnings at 3.5-4% per year over the next 5 years. That's rather meager growth expectations. However, I'm not that concerned because I believe that 3M is a really high quality company and that they'll figure out what levers to pull to reignite growth.
We've made some good headway on the debt reduction and one of the car loans will be paid off either before the end of August or sometime in September. Once that car loan is gone the current plan is to transfer enough savings each month to make one purchase, ~$1k, with the remaining cash flow going to debt reduction and building up our cash reserves. So needless to say I'm pretty excited about what the remainder of 2019 can bring.
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? Have you added shares to your own portfolio with the dividend yield near historic highs?