Dividend aristocrats are often viewed as reliable investments for income-seeking investors. These companies boast a track record of consistently paying dividends for many years, with some increasing their payouts annually. 3M is one such company, as they have been paying dividends consecutively for over 100 years with over 60 years of consecutive increase.
When it comes to dividends, the first thing that dividend seekers will look at is the dividend yield, how much dividend is received as a percentage of the stock price.
To maintain a high dividend yield, companies like 3M often resort to boosting their dividend payouts, even when their earnings growth may not support such increases. This strategy aims to entice investors by presenting an attractive yield, but it can pose risks if the underlying fundamentals do not support sustained dividend growth.
The spread between Earnings Yield and Dividends Yield of 3M has been declining from 2012 to 2020, as a result of rising stock price without a rise in earnings. Dividend-income seekers chase the higher dividends without considering the stock price, pushing the price even higher, and thus, forcing the company to increase the dividends payout even more.
At some point, 3M had to resort to debt to maintain the high dividend payout. This strategy has worked for 3M so far, but it is not without risks. If the company's earnings ever start to decline, it may not be able to afford to keep its dividend payments growing. In that case, 3M would have to either cut its dividend or take on even more debt, at higher interest rates.
In addition to paying dividends, 3M has also engaged in share buyback programs. However, when faced with financial challenges, the company is likely to prioritize dividend payments over share buybacks. This preference can have significant implications for shareholders since buybacks often provide more direct value by reducing the number of outstanding shares and increasing earnings per share. Besides, buybacks are more tax efficient than dividends.
While maintaining a high dividend yield may seem appealing, it can potentially lead to issues in the long run. A similar pattern has been observed in Real Estate Investment Trusts (REITs), such as GEO Group, which had to cut dividends due to financial difficulties. The focus on sustaining dividend payments can overshadow the importance of addressing underlying financial concerns and investing in long-term growth.
Here's the full analysis of 3M: https://research.ishfaaqpeerally.com/courses/662813/lectures/15532205