3M Co Stock Is a Winner, But Heed Its Valuation Risk

3M stock has a very rich valuation - so rich that it's unsustainable

By Luke Lango, InvestorPlace Contributor

3M MMM stock

Source: Dean Hochman via Flickr (Modified)

Following the demise of America’s formerly most powerful industrial conglomerate General Electric Company (NYSE:GE), many industry pundits have declared an end to the era of the multinational conglomerate.

But 3M Co (NYSE:MMM) has something different to say about that. MMM is a well-run and extremely profitable multinational conglomerate that is actively applying modern science principles to multiple aspects of everyday life, including safety, healthcare, electronics and energy. Despite GE’s demise, all of 3M’s business have been doing extremely well. That’s why 3Mstock is up 120% over the past five years, versus an 80% gain for the S&P 500.

Clearly, the era of the multinational conglomerate isn’t over. GE was just mismanaged for decades. 3M, on the other hand, has been appropriately managed. As a result, the company is firing on all cylinders right now, thanks to synchronized global economic strength. This operational strength should continue into the foreseeable future as 3M has constructed massive moats in some very big secular growth industries.

But just because 3M’s business model isn’t antiquated doesn’t mean 3M stock is a buy.

In fact, 3M stock has run up to valuation levels which I don’t understand.

Consequently, even though 3M is a winning company with big cash flows and a fat dividend, MMM stock looks due for weakness ahead. The current valuation is simply unsustainable.

Why 3M Stock Is Due for Weakness Ahead

MMM is a great company with its fingers touching everything that matters.

From safety to healthcare to electronics and energy, 3M is providing original equipment manufacturer (OEM) platforms and components for a bunch of secular growth industries — think automated driving, connected roadways, biomedical technology, data centers and so on. Considering the massive complexity inherent to manufacturing these components, 3M has also constructed massive moats in these secular growth industries. Thus, 3M has essentially guaranteed itself steady revenue growth potential over the next several years as global investment in things like automated driving, biomedical technology and data centers picks up.

Moreover, margins are on a multi-year uptrend. That should continue as the company faces very little competition at scale. Overall, this is a company with 3-5% revenue growth potential and 10% earnings growth potential over the next several years.

But that just isn’t enough growth to warrant the current valuation.

3M Stock Is Richly Valued

MMM stock is trading at 22-times forward earnings for that 10% earnings growth potential. That gives 3M stock a forward price-to-earnings/growth (PEG) ratio of 2.2, which is essentially double the current market average PEG of 1.1. That isn’t a terribly attractive value prop.

Moreover, across all important valuation metrics, MMM stock is trading at a huge premium to its 5-year average valuation. The dividend yield has plunged to multi-year lows, as has the free cash flow yield.

Across the board, MMM stock is very richly valued. Granted, a rich valuation hasn’t held this stock back in the past as healthy growth, steady margin expansion and robust cash flow generation have powered the stock higher.

But in a higher rate environment, valuation should start to matter a bit more. In that world where valuation is front and center, I don’t realistically see 3M stock — trading at more than double growth prospects and at a huge premium to historically average levels — heading much higher from its current price.

Bottom Line on 3M Stock

Great company. Great management. And great growth prospects.

But MMM stock is priced for all that. And more. At current levels, it’s tough to see this stock running higher alongside higher interest rates and in a market where valuation is front and center.

If you’re in MMM stock for the long-term, you’re probably fine. It will be higher in five years than where it is today. But I think a major valuation correction will happen in the meantime. I’ll wait for that correction to buy into this secular growth name.

As of this writing, Luke Lango was long GE. 

Article printed from InvestorPlace Media, https://investorplace.com/2018/03/3m-co-mmm-stock-winner-heed-valuation-risk/.

©2018 InvestorPlace Media, LLC