Diversified industrial icon 3M (MMM 0.73%) has a 6.1% dividend yield. The dividend has increased annually for over 50 years, making the company a highly elite Dividend King. And that hefty yield is the highest it has been in over 30 years. That sounds like a screaming opportunity, and it might just be one, but there's a big problem that led me to sell most of my position in the stock.
Relative dividend yield
In many ways, 3M is a perfect dividend stock for me, which is why I bought it. I prefer owning companies with long histories of paying reliable dividends that have fallen on hard times. The list of Dividend Kings is one of my favorite stomping grounds when looking for investment ideas. And one key factor I look at is historically high dividend yields, which I believe hints at a historically cheap stock.
Image source: Getty Images.
I've used this approach for years with great success. It led me to invest in Nucor, Eaton, Procter & Gamble, and General Mills, among many others. I've benefited from substantial gains in all four of those investments. I know my focus on relative dividend yield, looking for what I call fallen angels, isn't a wholesale mistake. But I also know that no investment approach works 100% of the time.
So the drubbing I've taken in 3M could be the odd miss, or more patience might be required for the company to work through its current problems. Indeed, the high yields I am attracted to are almost always associated with temporary company headwinds. (Note that 3M's stock is down over 60% from its high-water mark in 2018.) This is where my lesson lies and why I chose to capture much of the loss I had in 3M stock.
What's the problem?
Nucor, Eaton, P&G, and General Mills were all out of favor on Wall Street when I bought them. The problems were all different but similar in that they were temporary business headwinds. Each quarter there was an update on how the companies were handling the issues they faced and what level of success they were having in dealing with them. Basically, I could track management's progress.
That's not what is going on with 3M. The industrial giant has business issues, including slowing growth, inflationary margin pressures, and a pandemic demand spike for some products that is fading, that I can closely monitor. But the bigger issues today are legal and regulatory. Without getting too deep into the woods, 3M is dealing with product liability lawsuits tied to earplugs it sold to the U.S. military, lawsuits around the impacts of so-called forever chemicals it produces, and environmental cleanup of those forever chemicals.
Because of the legal nature of these problems, the company can't discuss them in great detail, leaving me without much guidance on the progress toward a resolution. I believe 3M is large and financially strong enough to weather the headwind, but I have no way to fully quantify the problem or track it. Given that another of my key investment tenants is that I don't want to leave my heirs with an investment that will be too hard for them to understand, I had little choice but to sell 3M as the company's legal and regulatory issues are unlikely to resolve anytime soon.
The big lesson for me is that legal and regulatory problems are best avoided because there are too many unknowns. While I could probably dig in and closely track 3M's legal and regulatory fortunes via legal filings and court outcomes, the effort would be overwhelming and leave me with little time to monitor the rest of my portfolio. The risk/reward benefit just isn't tilted the right way.
By comparison, I also own Stanley Black & Decker (SWK 0.16%), which is struggling mightily but I happily continue to hold. The key difference is that Stanley Black & Decker's problems are basically all trackable, with updates on the integration of acquisitions, debt reduction, margin improvement, and cost-cutting all provided at regular quarterly intervals. I can see the progress management is making, even though progress is slow and not always smooth.
Taking the hit
All in, with a sizable loss, I have decided to sell most of my 3M position and use the red ink to offset gains elsewhere in my portfolio. So the loss isn't a total, well, loss. But, more importantly, I learned a lesson about my investment approach that I believe will help me in the future. When I see a fallen angel, I need to both believe there is recovery potential and be able to track that recovery through the company's quarterly business updates. Some risks, notably legal and regulatory issues, just don't allow for that.
