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Key Takeaways from the Analysis of 3M Company’s Return on Equity

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Jun. 23 2016, Updated 9:09 a.m. ET

3M analysis

3M Company (MMM) has racked up impressive returns over the years. It has a mean annual return on equity (or ROE) of 30.1% for the ten-year period between 2005 and 2015. ROE can be distorted by excessive leverage taking, as seen in the formula below.

ROE = (tax burden) * (interest burden) * (EBIT margin) * (financial leverage) * (asset turnover)

3M has increased both its EBIT (earnings before interest and tax) margins and its leverage over the past ten years. The company’s tax and interest burdens have both fallen substantially over the years, which has translated into high net profit margins. These tax and interest burdens have fallen as 3M has moved toward a more efficient capital structure.

In 2015, 3M’s financial leverage, or debt to equity, was 30% higher than its 2005 and 2011 levels. Its financial leverage was 1.99x in both 2005 and 2011. However, 3M’s ROE in 2015 was 9.2 percentage points higher than its 2005 levels and 12 percentage points higher than its 2011 levels.

Therefore, the rise in 3M’s ROE has been rooted more in a rise in net profit margins than a rise in leverage.

3M’s high ROE highlights that it probably has a competitive advantage, which it’s exploiting to its benefit. We discuss some of the company’s advantages in the next two parts of this series.

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Key ETFs

Investors interested in trading in the industrials space can look into the Vanguard Industrials ETF (VIS) and the Industrial Select Sector SPDR ETF (XLI).

Major holdings in VIS include General Electric (GE) with a weight of 12.2%, 3M Company with a weight of 4.3%, and United Technologies (UTX) with a weight of 3.7%.

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