Streetwise

Lauren Rudd

Sunday, March 13, 2011

Volatility Can Translate Into Profit

Market volatility has increased quite dramatically of late and where there is volatility there is profit-making opportunity, despite the recent relatively low overall market volume. If you are reticent to act, perhaps because you are still in mourning over some previous loss, remember that 40 years of statistical data confirms an average annual compounded total rate of return for the equities markets of about 11 percent.

Yes, I am eminently familiar with the statement by famed economist John Maynard Keynes’s, “In the long run we are all dead.” More pertinent is the phrase that every journey begins with a first step. Unfortunately market volatility, when combined with a fear of the unknown, readily foments paranoia. Nonetheless, your task is to remain undeterred in your resolve to uncover true value.

Yes, I know. The next question is can I give you an example to start with. Well of course I can. A company with excellent potential going forward, and one that I have not written about in quite a few years, is the 3M. Barron’s recently put it very succinctly when they wrote that last year the world’s population continually interacted with the company’s products, from fiddling with Scotch tape, to leaving urgent messages on Post-its, to parking their posteriors on Scotchgarded furniture.

As you delve into the company, you discover that it derives about a third of its revenue from industrial and transportation products, such as car waxes and abrasives, while its second-largest unit, at about 20 percent of sales, is health care, including inhalers and orthodontic devices.

The consumer and office division, which houses Post-its and consumer tapes, accounts for less than 15 percent of corporate revenue but continues to grow as does the display and graphics unit. 3M also has an electro and communications unit that sells clear adhesives, high-capacity cables and flexible circuits for printers.

In 2010, 3M spent about $1.43 billion, or 5 percent of sales, on research and development, receiving 2,400 patents and launching 1,300 new products. As a result, 31 percent of the company’s revenue now comes from new products. The goal is 40 percent by 2015.

In the alternative energy field, 3M is selling a film that replaces the glass in solar panels, making them one-eighth as heavy, more flexible and far cheaper. The company’s technological ambitions span the scientific spectrum as it creates new multi-touch screens for casinos and a ceramic-core cable that can carry twice the voltage of a standard aluminum cable.

The product line includes high-margin software for passport scanners, oral scanners to allow dentists to precisely map a patient's mouth, while mundane products like Post-its, are continually improved to now use recycled paper and non-petroleum-based adhesives.

About 65 percent of 3M's sales come from abroad. The business plan is to always expand sales in a country at twice that country’s GDP growth rate. Last year, developing countries accounted for a third of all sales.

Historically 3M, which has a market capitalization value of $66.32 billion, has traded at a 10 to 20 percent premium to the S&P 500. However, the current 14.64 P/E, based on my projected 2011 earnings, places the company roughly on par with the S&P 500 forward P/E of 14.2, while still providing a dividend yield of 2.40 percent, as compared to 1.72 percent for the S&P 500 index.

In 2010, 3M earned $5.63 per share on revenues of $26.66 billion. For 2011, 3M’s guidance is for 5.5 to 7.5 percent internal revenue growth and earnings of $5.95 to $6.20 per share, after pension expenses. The intrinsic value of the shares using a discounted earnings methodology is $113, while the more conservative free cash flow to the firm model yields an intrinsic value of $119.