<FOOLISH FOUR PORTFOLIO>

3M Announces Earnings
Recovering nicely, thank you!

by Ann Coleman (TMF [email protected])

RESTON, VA (July 29, 1999) -- Well, the Dow took a hit today, dropping one and a half percent -- and our Foolish Four portfolio followed suit. Twenty-six of the Dow stocks lost money, and only two managed more than 1% gain: Procter & Gamble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %> and our former laggard, 3M <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MMM)") else Response.Write("(NYSE: MMM)") end if %>.

As we discussed Monday and in keeping with our hands-off portfolio management philosophy, it's rather rare that I even mention the market or an individual stock's price performance. Today's rise by 3M, though, is a perfect example of how the Foolish Four strategy works, so let's look at it a bit closer.

For those interested in background on 3M, Chris Rugaber's two part series (See the Foolish Four Reports of June 24 and 29 in the archives) gives a nice overview of the company and how it became a Dow pariah. The Reader's Digest version is that the company was hard hit by the Asian currency crisis of 1997. In fact, the company is still 10% below its June 1997 high.

3M has lagged the other Foolish Four stocks this year so far (even while beating the Dow as a whole). So what caused an almost 2 percent rise on a day when the entire market had a bad case of interest rate jitters?

Profits. Earnings per share (EPS). Money, pure and simple. Profits now and the prospect of more to come. The company reported a 9.6% increase in earnings per share this morning (excluding one-time items) with increased revenues and better margins compared to the second quarter of last year. The increases were attributed to recovery in Asia, growth in new products, and a decrease in expenses, all part of the company-stated plan for improving shareholder value.

What about those one-time items, though? Adjustments for one-time items are so common these days that it could lead one to wonder if all those items shouldn't be counted somewhere. Especially when companies are talking about one-time losses, which isn't the case here. 3M's one-time items were the profits from the sale of two business, and that cash is certainly not ignored. If you count it, earnings per share would have shown an increase of 24.5% over last year.

So why isn't it counted? Well, of course, it is. That cash is nicely in the pockets of 3M and will eventually be shared with stockholders in the form of dividends or increased investment. But when it comes to earnings per share, analysts want to see how the company is growing those earnings, and a one-time windfall like that can obscure what is really going on with the company. The same thing is true of "restructuring costs" and other one-time losses.

The reason those one time charges are left out is so that investors can see clearly how the day-to-day business is growing -- and can, hopefully, project that growth reliably into the future. If one-time items are included, the ability to project how the company's future earnings are likely to grow is lost and comparisons between quarters become meaningless.

So while it's great that 3M made $104 million by selling off two of its businesses, that's really not relevant to its future earnings. The 9.6% increase in EPS compared to last year is quite relevant, and the increase in net profit margin, from 10.2% to 10.9%, is even better news.

As Chris Rugaber wrote in his second report on 3M, "If the company can successfully execute its restructuring and introduction of new products this year and gets a little help from the global economy, more upside potential certainly exists." It looks like we are seeing a bit of that.

The specifics of how 3M has turned around are interesting by themselves, but from a larger perspective, they illustrate just how the Foolish Four strategy is supposed to work. The RP formula identified 3M as a stock with a good yield and a beaten-down price. We bought it. The strength of Dow companies to weather storms such as the Asian crisis brought 3M through the bad times and, as the price recovers, we ride it up.

Not every stock tagged for the Foolish Four will behave this way. After all, the RP is just a simple mathematical formula, not a crystal ball -- but this year at least, everything is working according to plan.

Did I just say that? Sell your stocks! I think I've jinxed them.

Fool on and prosper!

Today's Stock Lists | 1999 Dow Returns

07/29/99 Close

Stock Change Last -------------------- CAT -2 3/8 58.88 JPM -3 3/8 130.63 MMM +1 11/16 90.81 IP - 15/16 52.31

Day Month Year History FOOL-4 -1.63% -0.32% 25.37% 27.23% DJIA -1.65% -1.64% 18.32% 17.85% S&P 500 -1.78% -2.31% 9.67% 9.94% NASDAQ -2.43% -1.70% 20.40% 22.05% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 58.88 36.66% 12/24/98 9 JP Morgan 105.51 130.63 23.80% 12/24/98 14 3M 73.57 90.81 23.44% 12/24/98 22 Int'l Paper 43.55 52.31 20.12% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1413.00 $379.00 12/24/98 14 3M 1030.00 1271.38 $241.38 12/24/98 9 JP Morgan 949.62 1175.63 $226.01 12/24/98 22 Int'l Paper 958.12 1150.88 $192.76 Dividends Received $49.99 Cash $28.26 TOTAL $5089.13