Tim Bovee, Private Trader: MMM: Less than meets the eye

3M Co. (MMM) has long been on the rise, but the odds and yields suggest that there is less to the uptrend than initially meets the eye.

The Chart

Elliott wave framing places MMM is in the 3rd wave of a 3rd wave its rise from $68.63 beginning in October 2011. That means the price has more upside potential.

However, it is in the final wave of the uptrend of lower degree that began in June 2012. A correction lies ahead, although how far away it is in price and time no one can say.

Click on chart to enlarge.

MMM 6 years weekly bars (left), 9 months daily bars (right)

What is clear is that within that 5th wave, which I've labeled as wave 5 {+1}, MMM is in the middle wave, which I've called waved 3, and within the final wave, 5 {-1}, within wave 3.

In assessing MMM, timing of things is all important. Wave 3 began last March from $129.70, or 14% below today's opening price. The correction, when it comes, is unlikely to be so steep as to break the bank, especially given the fact that corrections typically take back only a portion of the prior rise.

There is enough here to make a trader nervous that a counter-trend correction lies ahead, yet the analysis suggests that even if a bull position is caught in the correction, it is unlikely to be devastated.

Odds and Yields

MMM has completed three bull signals since wave 5 {+1} began on Feb. 3, 2014. One was successful, earning 1.6% over 101 days. The two unsuccessful trades on average lost 2.5% over 13 days.

None of the signals occurred during the present wave 5 {-1}, which began Aug. 6.

The odds are not only skewed toward loss, the negative 0.9% win/lose yield spread says that whipsaws do slightly outsized damage to a position, and the difference in duration, 101 days for the winner vs. 13 for the losers, suggests that the winner was an outlier, outside of what I would normally expect.

The Company

3M, headquartered in St. Paul, Minnesota, has moved far beyond the simple roll of Scotch Tape that was its claim to fame among consumers. It designs and manufactures more than 55,000 products for construction, dental and medical, electronics, car care and other sectors. It has operations in more than 65 countries.

Analysts are less than excited about 3M's prospects, collectively coming down with a negative 8% enthusiasm rating.

The company reports return on equity of 27% with debt amounting to 30% of equity. This puts 3M into growth-stock territory by my criteria.

Earnings have been working their way upward for the past three years. They have surprised to the downside twice in that period, in the 4th quarter of 2013 and the 1st quarter of the current year. All but one of the other quarters surprised to the upside.

The earnings yield is 4.81%, compared to 2.59% for the 10-year U.S. Treasury note. The dividend yield, annualized at today's prices, is 2.33%.

The growth forecast, combined with the dividend, implies a "fair" price of $100.45, suggesting that MMM is overpriced by 46%. I've marked that price level on the left-hand chart in purple.

The stock is selling at 21 times earnings, and also at a high multiple of sales. It takes $3.03 in shares to control a dollar in sales.

Institutions own 66% of shares.

3M next publishes earnings on Oct. 23. The stock goes e-dividend in November for a quarterly payout of 85.5 cents per share.

Liquidity and Volatility

MMM on average trades 2 million shares per day and supports a wide selection of option strike prices spaced $5 apart, with open interesting running to three and four figures near the money.

The front-month at-the-money bid/ask spread on calls is 4.8%, compared to 0.4% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 14%, compared to 12% for the S&P 500, and began falling earlier this week after a rise lasting a couple of weeks. Volatility stands in the 10th percentile of its one-year range, suggesting that long vertical spreads, bought with a debit and expiring in an out month, will have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $141.10 and $153.04 over the next month, for a potential gain or loss of 4.1%, and between $144.20 and $149.94 over the next week. I've marked the one-year range on the right-hand chart in blue.

Contracts are trading actively today, with calls running more than triple their five-day average volume and puts at 50% above average.

Decision for My Account

The poor odds of success with MMM give me pause, as does the relatively low potential gain implied by the options pricing. It comes down to a big risk for a small reward, never a good situation to jump into.

Otherwise, MMM seems like an exemplary bull play.

However, the odds and potential gain are big hurdles to overcome. For that reason, I'm declining to take a bull position in MMM.

-- Tim Bovee, Portland, Oregon, Sept. 19, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.