Summary of July choices

Based on price performance, the Dividend Growth Stocks model portfolio (+ 1.3%) underperformed the S&P 500 (+ 1.7%) by 0.4% from July 29, 2021 to August 24, 2021. On Based on total return, the model portfolio (+ 1.5%) underperformed the S&P 500 (+ 1.7%) by 0.2% over the same period. The best performing stock rose 10%. Overall, 15 of the 30 dividend growth stocks outperformed the S&P 500 from July 29, 2021 to August 24, 2021.

The methodology of this model portfolio mimics an All Cap Blend style with an emphasis on dividend growth. The selected stocks achieve an attractive or very attractive rating, generate free cash flow (FCF) and positive economic earnings, offer a current dividend yield> 1% and have a history of more than 5 years of consecutive dividend growth. This model portfolio is designed for investors who focus more on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.

Featured Action From August: 3M Company


3M Company (MMM) is the flagship stock in the August Dividend Growth Equity Model Portfolio.

3M has increased its revenue by 2% compounded annually and net operating income after tax (NOPAT) by 3% compounded annually over the past decade. Longer term, the company has grown NOPAT by 6% compounded annually since 2000. The company’s NOPAT margin has increased from 16% in 2016 to 18% in the last twelve months (TTM).

Figure 1: NOPAT and 3M company’s turnover since 2016

Steady dividend growth supported by FCF

3M has increased its regular dividend each year from $ 0.325 / share in 1989 to $ 5.88 / share in 2020, or 10% compounded annually. The current quarterly dividend, when annualized, is $ 5.92 / share and offers a 3% dividend yield.

More importantly, 3M’s strong Free Cash Flow (FCF) supports the company’s growing dividend payments. 3M generated a cumulative $ 18.4 billion (16% of current market cap) in FCF while paying $ 15.4 billion in dividends from 2016 to 2020, as shown in Figure 2. During the period TTM, 3M generated $ 6.6 billion in FCF and paid $ 3.4 billion in dividends.

Figure 2: Free Cash Flow Versus Regular Dividend Payments

Companies with FCFs that far exceed dividend payouts offer opportunities for higher quality dividend growth because I know the company is generating the cash to support a higher dividend. On the other hand, one cannot trust the dividend of a company where the FCF is lower than the dividend payout over time to increase or even maintain its dividend due to insufficient free cash flow.

MMM has upside potential

At its current price of $ 193 / share, MMM has an economic price to book value (PEBV) of 0.9. This ratio means that the market expects 3M’s NOPAT to permanently decline by 10%. This expectation seems too pessimistic for a company that has grown NOPAT by 6% compound annually over the past two decades.

Even though 3M’s NOPAT margin falls to 15% (equivalent to 10-year low, from 18% TTM) and the company’s NOPAT only increases by 2% compound annually for the next decade, the stock worth $ 238 / share today – a 23% upside. See the math behind the reverse DCF scenario.

If the company grows NOPAT more in line with historical growth rates, the stock has even more potential. Add 3M’s 3% dividend yield and dividend growth history, and you’ll see why this stock is part of the August Model Dividend Growth Stock Portfolio.

Critical details found in financial documents by my company’s Robo-Analyst technology

Below are details of the adjustments I make based on Robo-Analyst’s results in 3M’s 10-K and 10-Q:

Income statement: I made adjustments of $ 1.4 billion with a net effect of removing $ 272 million in non-operating expenses (> 1% of revenue). See all adjustments to 3M’s income statement here.

Balance sheet: I made $ 16.0 billion of adjustments to calculate invested capital with a net decrease of $ 4.4 billion. The most notable adjustment was $ 7.7 billion (19% of reported net assets) in other comprehensive income. See all 3M balance sheet adjustments here.

Valuation: I made adjustments of $ 30.8 billion, with a net decrease in shareholder value of $ 21.2 billion. Besides total debt, the most notable adjustment in shareholder value was $ 4.8 billion in excess cash. This adjustment represents 4% of 3M’s market value. See all 3M valuation adjustments here.

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation for writing about a specific action, style, or theme.