Want $2,000 in Passive Income? Invest $10,000 in this Dow Dividend King and wait 5 years

The stock market is full of surprises and can be extremely unpredictable in the short term as fundamentals collide with a mix of fear and greed.

And although the long-term history of S&P500 is excellent (around a compound annual growth rate of 10% since 1965), the stock market rarely shows an annual return of between 8% and 12%. In fact, the S&P 500 has produced an annual return of between 8% and 12% in just four of the past 50 years – in 1971, 2004, 2014 and 2016.

One of the most proven ways to combat volatility is to invest in quality dividend-paying stocks that give you regular payouts no matter what the stock market does. 3M ( MMM -1.71% ) has paid and increased its dividend for 64 consecutive years, making it one of the oldest members of the shortlist of Dividend Kings – S&P 500 stocks that have paid and increased their dividends every year for at least 50 years consecutive. The track record is impressive, but an investment is only good based on where it’s headed, not what it’s done in the past.

Investing $10,000 in 3M stock should earn you at least $400 a year in dividend income, or $2,000 over five years. However, this calculation assumes that 3M keeps its dividend the same for five years – when in reality – the amount of dividend income per year is likely to be higher given 3M’s history of increasing the dividend. Here’s why 3M is a dividend stock worth considering now.

Image source: Getty Images.

A company in disgrace

The chart for 3M stock is about as ugly as it gets. The company has significantly underperformed the S&P 500 over the past year, three years, five years, seven years and 10 years, even taking dividends into account. The last five years in particular have been a horror. Investing $1,000 in 3M five years ago would have left you with only $938 today versus $2,080 in the S&P 500.

MMM Total Achievement Level Table

MMM total performance level. Data by YCharts.

In many ways, the stock deserved to underperform the market. The company launched a restructuring program in the fourth quarter of 2020 that has already cost $260 million with more to come. However, 3M thinks the program will be worth it in the long run because it will get rid of features that aren’t contributing to its growth.

Overall, the restructuring has been a minor success so far, as 3M’s margins have held steady while revenue and net profit have rebounded. But it’s the company’s revenue and profit growth rate that has been weak. Revenue was up just 11.7% from five years ago, while net profit was up just 21.9%. The outlook is bleak too. 3M expects organic sales growth of 2% to 5% in 2022 and earnings per share growth of 0% to 5% from 2021.

A cheap valuation

With all this bad news, investors might be wondering what makes 3M a good buy now. It has disappointed investors year after year and has consistently missed or lowered forecasts, so there’s likely a “prove it” factor hanging over the stock right now. When expectations are extremely low on what remains a highly influential and diverse company, it is often the perfect time to do business and buy.

What really makes 3M stock attractive today is its valuation.

Chart of MMM Price to Free Cash Flow

MMM price to free cash flow. Data by YCharts

In terms of price/free cash flow (P/FCF), price/earnings (P/E) and enterprise value/earnings before interest, taxes, depreciation and amortization (EV/EBITDA), 3M stock is the cheapest it has had since 2013.

As Warren Buffett said, “you pay a very high price in the stock market for happy consensus,” which basically means that companies that are doing well are expensive. The reverse is true with a company like 3M, where it has problems and so investors can pay a low price because it’s a mixed bag.

The reality is that 3M’s timeline for returning to meaningful growth is unknown. And even if it does, can it make the necessary changes to avoid losing market share over time? That’s the uncertainty 3M faces right now. Therefore, I would say it’s more important to focus on what we know, which is the company’s balance sheet strength, low valuation and attractive divisional performance. In terms of a source of passive income in an inflationary environment, 3M seems like a good option now. Investors who want to avoid uncertainty can simply wait a few years to consider 3M once we can better assess the company on the other side of its restructuring. The downside is that if 3M corrects the situation, its valuation will likely be more expensive.

Get paid to wait

3M stock will likely continue to languish until it can regain its footing and return to growth. Investors who choose to give the company the benefit of the doubt will receive a 4% dividend yield for their patience and the comfort of knowing they are getting the stock at a cheap price relative to its earnings and its free cash flow.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.