Blue chip stocks rarely go on sale. When they do, it pays to do your research. High-quality businesses trading at deep discounts are the ultimate buy-and-hold opportunities.
For decades, 3M (MMM -2.47%) was the epitome of a blue chip stock. Shareholder returns consistently beat the market, and the company's diversified, recession-resistant business model insulated the stock during times of turmoil. With that in mind, the last few years have been exceptional, and not in a good way. Shares have lost around 65% of their value since 2018, pushing the valuation down to multidecade lows.
Has 3M stock become the ultimate buy-and-hold opportunity?
The core business is solid
The best buy-and-hold stocks have business models that consistently make money in nearly any environment, typically over long stretches of time. This consistency is the reason you can invest for the long term with minimal worry. In that regard, 3M is still very much the ideal buy-and-hold stock.
In a nutshell, the company is an industrial materials company with a portfolio of thousands of specialized products that serve a wide array of end markets all over the world. You may use some of the company's consumer products yourself, things like personal respirators, heat-resistant tubing, and safety goggles, though it also owns respected brands like Scotch tape, Post-it Notes, and Scotch-Brite cleaning products. The majority of 3M's sales, however, target larger buyers, with products like automotive adhesives, surgical tools, and optical films.
It's almost impossible to summarize all of 3M's products, but know this: The company owns thousands of patents and spends nearly $2 billion annually for research and development, ensuring its products are differentiated and command high margins. 3M's ability to innovate and charge premium prices is easily verifiable. For decades, research and development spending has continued to rise, and returns on equity have remained exceptionally high, averaging above 30%.
As you can see from the chart below, something strange has happened in recent quarters, but it has nothing to do with the ongoing success of its underlying business model.
MMM Return on Equity data by YCharts.
Understand this one challenge
The problem plaguing 3M today is simple in nature, but the ultimate effects are still unknown. All we know is that the company settled a lawsuit last summer for around $10.3 billion. The lawsuit charged 3M with contaminating public water supplies with PFAS, a chemical used in many of its products, including firefighting foams and consumer products. Notably, 3M began to phase out many PFAS substances in early 2020 and will stop producing all PFAS products over the next 12 to 24 months.
The primary challenge following the settlement is whether 3M will face further fines or litigation related to its PFAS use. This is where the near-term direction of the stock becomes incredibly murky. It could take years to fully quantify 3M's liabilities. From a cash-flow perspective, however, the company is in little danger. 3M generates between $1 billion to $2 billion in free cash flow every 90 days. Its dividend, which currently yields above 6%, could also be slashed to conserve cash for potential legal setbacks.
What will become of 3M? At a minimum, expect a larger conglomerate to purchase the company at a discount. That's exactly what happened when Monsanto faced its own multibillion-dollar lawsuits related to its Roundup products. The company had generated high returns on equity for years, just like 3M. When legal challenges arose, pressuring the stock, the company was soon purchased by its larger competitor, Bayer.
This isn't an investment worth backing up the truck for, given that there are so many unknowns. But for buy-and-hold investors willing to take a little extra risk in exchange for a bargain entry point, 3M looks like an attractive option. Once the legal challenges are quantified, the market can return to pricing the company as the blue chip stock it is.
