There's a saying on Wall Street that you should buy when others are fearful, which is much easier said than done. However, if you focus on dividends as I do, it can help overcome the hesitancy that is natural during difficult times.
Today, industrial giant 3M (MMM 3.18%), which currently has a historically high yield, looks very attractive, but only if you can see beyond the near-term negatives it faces. Here are three reasons why I own the stock despite some big, ugly warts.
1. Cyclical business
Industrial stocks like 3M are inherently cyclical, with demand for their products, often sold to other companies, rising and falling along with economic activity. Right now, investors fear a broad recession as central banks around the world increase interest rates to combat inflation. That's a very reasonable worry, but if history is any guide, recessions, even very bad ones, eventually come to an end. Then the next expansion starts and expansions tend to last longer than contractions.
Image source: Getty Images.
Yes, 3M's business will get hit if there's a recession. However, with roots going back more than 100 years, the company has seen a fair number of economic cycles and has survived them all. I'm confident that the company will figure out how to deal with the next one (and the ones after that as well). Really, dealing with economic cycles is just part of the business, not something to get overly worried about.
2. Slow growth
Another concern for investors is that 3M hasn't exactly been lighting the world on fire lately. For example, over the past decade, revenue growth was in the low single digits. Year-over-year organic sales growth in the second quarter was a meager 1%.
Management needs to work on that, and it has been, but there are a lot of moving parts right now, including lingering pandemic impacts, geopolitical issues, and supply chain constraints. There's no easy solution; it will just take time.
And yet the near-term ups and downs aren't the real story here. The company has a long history of investing in research and development, which produces uneven results. It is hard to predict when the next big discovery will be found. However, when it does arrive, 3M has proven it knows how to take advantage of it by spreading the innovation throughout its product portfolio.
I believe, based on the history here, that the company will eventually find, or perhaps buy, some new technology that it will be able to use to get its business back on the growth path.
Key Data Points
3. Legal and environmental concerns
The next negative facing 3M today is its legal fights over earplugs sold to the military and environmental clean-up costs. These will be costly issues, win or lose. The company continues to fight on both fronts but recently took steps to protect itself and shareholders by pushing the division (Aearo Technologies) that makes earplugs into bankruptcy. The stock jumped on the news. This is the same tactic that Johnson & Johnson took with its talcum powder legal costs. It is probably a good move for 3M to go down this path.
The company is also spinning off its healthcare division. While I'm less pleased by this move, it should help the company reduce leverage as it pushes debt onto the spinoff. That will free up liquidity that will help 3M deal with the financial costs of its legal and environmental headwinds.
My concern is that the spinoff, which accounts for nearly 25% of the company's current sales, will be used as a justification for a dividend reset. Time will tell, but I'm willing to give the company the benefit of the doubt here and will likely continue to hold it even if there is a dividend cut.
3M also has an $80 billion or so market cap and an investment-grade-rated balance sheet. It should be able to handle these costs over time, particularly if the effort to corral the company's earplug risks works as planned.
It won't be pretty, given that the company has already committed to a $1 billion fund for earplug litigation payouts. The figure could still go higher. But, from a big-picture perspective, the company is likely to survive these headwinds and, frankly, legal and environmental issues are really just a part of running a giant industrial business.
Risk versus reward
So there are ample negatives here, which has led the stock price lower. It is down around 45% from its 2018 highs, with the 4.4% dividend yield sitting near levels not seen since the Great Recession. And yet the biggest problems 3M is facing seem surmountable in time (there's probably no rush to buy the stock, if you wanted to build a position over time).
All in, the risk/reward balance seems skewed toward the positive for long-term investors. And the generous quarterly checks you collect will provide you with something other than the bad news to watch.
