MMM: Post-Its and Magic Tape Could Stick the Landing
Courtesy of Dr. Paul Price
It’s hard to go wrong over the long-term with shares of a high-quality, predictable growth stock. That’s especially true when it sports an A++ balance sheet and provides a 2.56% current yield.
Diversified manufacturer MMM now trades near its best (read: lowest) multiple in a couple of decades, excepting the 2008-09 low. 3M’s yield is similarly higher than its average distribution rate in the most recent 10 years.
Value Line gave the shares great ratings in three of four of their key metrics. They rate only average in ‘price growth persistence’ because they were trading for north of 24x earnings a decade ago.
Soft economic conditions have led to tempered estimates. Zacks now sees $6.32 for calendar 2012 and $6.84 for next year. These estimates represent all-time record EPS.
3M has a 10-year median P/E of 17.6x. Post-recession, it has averaged just a shade under 14.5x. A rebound to simply 14.5 times expectations for 2013 would support a price near $100. A return to MMM’s long-term average yield of 2.36% would also indicate a $100 target based on the present 59-cent quarterly payout.
MMM typically increases its dividend early in each new year. A higher absolute payment could shift my one-year target zone to a higher level. Research firm Morningstar is of a similar mind. Morningstar calls present-day fair value as $100 and assigns MMM with a 4-star (of 5) Buy Rating.
Option savvy traders might want to consider buying 100 shares now while selling a January 2014 13-month call at a $95 strike and a January 2014 put with a $90 strike.
Note: This position is referred to as a "Buy-Write" – buying the stock, selling a call and selling a put. Overall, it's a bullish position, but the sold call will move in the opposite direction of the stock and the sold put. Both the stock and the call move together, but in this case, we would be long the stock and short the call (also known as a "covered call"). The sold put will move in the same direction as the stock – while the stock and the put move in opposite directions.
Here’s what that trade would look like overall at current quotes.
Those who simply buy MMM might expect about 8% – 10% 12-month total returns. Combining share purchase along with the sale of January 2014 calls and puts could provide larger gains. That would occur if the stock goes up modestly, does nothing, or even declines a little. With the Buy-Write strategy, a loss would not be incurred unless the stock drops below $83.76 at the expiration of the sold options in January 2014. That is the benefit of SELLING option premium.
Disclosure: No position at the time of writing
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