This Defensive Stock Just Proved Itself During The Downturn

Investors are thrilled to say goodbye to the month of August. Extreme levels of volatility and stunning market drops have given investors a sense of whiplash for the past few weeks.

#-ad_banner-#But the chaos brought a silver lining: At least we now know which stocks will hold their own in a sharp market pullback, and which ones represent too much risk and volatility.

Case in point: the relatively muted action in shares of Dow component 3M Co. (NYSE: MMM). This stock had been slipping out of favor before the market meltdown, thanks to a broader malaise among industrial stocks. A modest reduction in 2015 and 2016 consensus EPS forecasts hasn’t helped either, after 3M reported a pair of tepid quarters. But when true adversity struck, shares held their own, as if investors suddenly remembered all of the reasons why 3M is a stock to hold through thick and thin.

As you can see below, 3M’s stock lost roughly 3% of its value at a time when the broader market, represented below by the S&P 500, fell more than twice as much, and many mid-cap and small-cap stocks fell by double-digits.


A Cash Generator With Growing Dividends
Even in a panic-driven selloff, investors will think twice about dumping a stock with a generous $4.10 per share dividend. That juicy payout is the result of two straight years of dividend increases in excess of 20%. The current yield stands at 2.9%, roughly 30% above the average yield in the S&P 500. The fact that 3M has increased its dividend for 57 consecutive years is one of the factors behind my colleague Nathan Slaughter’s decision to place this shareholder-friendly firm in StreetAuthority’s Total Yield portfolio.

Although it’s best known for certain brands of consumer products like Post-It Notes, Ace Bandages and Scotch Tape, 3M delivers consistent dividend growth through success in numerous industries. For instance, it’s also a leading supplier of online library systems, water filtration devices, heavy duty adhesives and reflective paint, among many other products.

Importantly, the firm enjoys strong brand loyalty across industries, not just in consumer markets. And entrenched brands can support strong organic volume growth, premium product pricing and modest but consistent price increases.

3M’s strong brand leverage and market share leadership has translated into steady, recurring revenue streams. Yet the greatest appeal for this company may lie in management’s impressive cost management. 3M’s net profit margins have risen in the past few years to around 15%, roughly triple the margins of the typical industrial stock. Free cash flow has also been on the rise, reaching $4.8 billion in 2014. This suggests plenty of room for more dividend raises.

Another key sign of 3M’s dividend growth potential: the free cash flow margin, a ratio expressing the amount of cash generated per dollar of sales. 3M’s 15% free cash flow margin means this company is a cash cow. In 3M’s case, independent equity research firm Valuentum Securities Inc. expects this metric to average more than 17% in the coming years.

3M Is Still An Innovator
Some analysts have been questioning 3M’s commitment to innovation, perhaps because the firm isn’t grabbing headlines with hot new consumer products the way it did with Post-It Notes years ago. Even in the absence of a similar new blockbuster product, there’s no doubt the firm is still a top innovator.

For one thing, it traditionally spends 5%-to-6% of the top line on research and development (R&D), and that hasn’t changed. Current R&D expenditures of nearly $1.8 billion annually are 5.7% of revenue, and management says it plans to raise that ratio to 6% by 2017.  Importantly, R&D spending is producing documented results — steady increases in 3M’s New Product Vitality Index (NPVI), which shows the proportion of sales from products developed during the past five years. The NPVI is currently 33%, compared with 25% in 2008.

Examples of recently-introduced products include Scotchprint protective car wrap; Filtek Bulk Fill for use in dental restorations; films that brighten colors on cellphone screens and other liquid crystal displays; and Scotch Extreme Fasteners, a product designed to compete with Velcro.

Because R&D remains a top priority, management sees the NPVI climbing to 40% by 2017. During that time, the firm also expects annualized organic sales growth of 4%-to-6% in local currency terms (the bulk of sales occur outside the United States) and earnings per share gains of at least 9% annually.

As an innovator, 3M typically spends far more on R&D than acquisitions. But it recently completed several large deals that should help in meeting profit goals as well.

For instance, the $1 billion purchase of specialized filtration products from Polypore International in February, 2015 has boosted 3M’s already large presence in the fast-growing markets for filters used in healthcare and manufacturing. A more recent $2.5-billion buyout of Capital Safety Inc. increases the firm’s leadership in the market for safety-related equipment such as harnesses, nets and self-retracting lifelines.

Add it all up, and 3M continues to pull out all the stops to ensure consistent growth in sales and profits.

Risks To Consider: As a multinational firm, 3M is highly exposed to U.S. dollar strength. The strong greenback explains why earnings forecasts have been trimmed by a few percentage points in recent quarters.

Action To Take: Steady, reliable dividend aristocrat 3M Co. is exactly the type of stock you want to own in tumultuous times, since it typically holds up well when the market plunges. 3M is an outstanding long-term investment, too, for growth and income. If you haven’t yet availed yourself of recent opportunities to buy the stock with prices down, consider doing so now. With the Federal Reserve always prepared to soothe the market with dovish rhetoric, it probably won’t be long before shares head sharply higher.

Editor’s Note: 3M returns even more money to shareholders in another way… share repurchases. In fact, share repurchases are such a powerful tool that StreetAuthority devoted an entire newsletter to identifying shareholder-friendly firms that pay dividends and buy back shares. These stocks, which we call Total Yield stocks, have proven to beat the market — even during the 2008 financial crisis and the dot-com bubble — and serve as reliable income investments. To find out more about Total Yield investing, click here.