Barron’s article on MMM Stock outlook and Corequity valuation

Barron’s published a bullish article on MMM ($90) this weekend providing us with an opportunity to see whether the favorable outlook presented is discounted in the stock price.

http://online.barrons.com/article/SB50001424052970204395804576162513319109354.html?mod=BOL_twm_ls#articleTabs_panel_article%3D1

Our valuation research substantiates that MMM stock is undervalued which also fits with our recent study of the current valuation of Big Caps vs Small caps.

Given that MMM's earnings are cyclical to a degree, we normalize them using the RoE  series of earnings and estimated earnings as shown here.

In this case, we get normalized earnings of $6.99 for 2012.  As this RoE level is substantially lower than the company achieved in the last cycle, it may represent a conservative assumption. Despite this, we have a stock that is undervalued by over 40% as indicated below.

This valuation forecast is based on an assumed return to the normal level of relative valuation which in this case is a premium of 20% to the S&P 500.

If we forecast a return to the RoE levels of 2006, we get normalized earnings of $8.19..

Under this assumption MMM is substantially more undervalued.

RLC

Big Caps vs Small Caps

Valuation Return or Risk (VR) is a measure of under and over valuation.  The graph  below shows the degree of undervaluation (positive VR) that the smallest market cap quartile stocks developed by the first quarter in 2009. By contrast the largest market cap stocks were overvalued although not to the same degree.

After Mar '09 the Small Cap stocks had an extraordinary run and the valuation now favors the Large Market Cap stocks

The Valuation of Growth vs Value

By using our database of 75 months of data on over 500 US equities, we can analyze the top and bottom quartiles of Growth and Value respectively. The first graph shows the average Valuation Return or Risk (VR) for each of the top quartile of growth (as measured by the Reinvestment Return) and the bottom quartile of value (as measured by Payback), by month, as shown below.

The divergence in value between high growth and low payback stocks takes place over a protracted period from the spring of 2007 to the end of 2008.  This can be seen in the relative performance of the indices below.  In May '07 the two are equal at 93 approximately.  There followed a relative gain of 22% for the growth stocks and a relative decline of 35% for low payback stocks for a divergence of close to 60%!

Referring to the first graph, our valuation favors low payback vs growth by +46% to +21%.  The median values are slightly further apart (+46 and +17).

Some background ...

In the late 1960s Robert Colby co-founded Marcinvest Fund, a no load equity mutual fund in Canada. As manager, he developed a valuation methodology to ascertain whether street expectations were already discounted in the stock prices. In the early seventies Marcinvest was merged with Altimira Management and Robert continued as the sole equity manager.

In 1976, he moved to Boston to sell an institutional equity valuation service (under Colby Equity Valuations, Inc.). The valuation model was computerized in order to cover a large number of equities. Its primary goal is in identifying overvalued and undervalued equities.

The institutional clients who subscribed to the service included Allied Signal, Canadian Pacific, Canadian Broadcasting, General Electric, Ontario Hospital Association and Ontario Municipal Retirement System, Choate Hall & Stewart, Fidelity International, Fiduciary Trust Company, The First Church of Christ Scientist, Gardner & Preston Moss, Harvard Management Corporation, Jarislowsky Fraser, Massachusetts Financial Services, Thorne Ernst & Whinney, United Financial Management and Wellington Management. In addition, Robert was President of Manasset Corporation, a family office in Providence, RI. Mr. Colby’s equity valuation service was re-started over 7 years ago.

Robert Colby has had extensive corporate Board experience both as board member and officer of a number of for profit and non-profit organizations. A graduate of McGill University, he maintains residences in Dedham, Ma and Georgeville, Quebec.