Common sense doesn't always lead to profitable investing decisions. In fact, making an investment based on what feels good or appears to be common sense can often lead to losses.
This is because the stock market tends to attract the highest number of investors at exactly the wrong time. Professional investors understand this and generally buy a stock when the public is scared or simply not interested.
One of the hardest things for new investors to grasp is the basic rule of buying weakness and selling strength. Common sense and the feel-good method of investing is to buy a stock when it is going up. Professional investors buy stocks on pullbacks and sell into strength -- the exact opposite of what the majority does.
I'm not suggesting that buying strength or when a stock is climbing never works. Under certain circumstances, breakout trading or strength buying makes sense. However, most of the time, waiting for a pullback in an overall uptrend creates the optimal entry level.
The reason for this fact is big-money investors generally only buy bargains. They never want to pay top dollar for any asset. The professionals understand the difference between value and price. When a stock sells off, the price drops but its true value remains the same. I call this buying value at a discount, and it's the basis for the majority of professional investors' stock purchases.
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An easy technical analysis tool for finding price drops that are likely to be bought by professional investors is the simple moving average. Big money watches both the 50- and 200-day simple moving averages to gauge whether a pullback will turn into a sell-off or whether it should be bought. The 200-day SMA is the primary moving average used by institutions to illustrate that an uptrend is still intact. Depending on the nature of the particular stock, the 50-day SMA may also used.
Dow stalwart 3M (NYSE: MMM) has been a classic example of the market rule of buying weakness and selling strength. As you can see from the daily chart, every time the price falls back to the 50-day simple moving average, investors step in and buy shares, sending the price ever higher. This is because price drops below the perceived value. Professional investors step in with buy orders to take advantage of the price/value disconnect.
Let's take a closer look at 3M to see whether this buying weakness trend is likely to continue. With a market cap of more than $93 billion, 3M is the fourth most heavily weighted stock in the Dow Jones Industrial Average, which means that it exerts a powerful influence on the benchmark index. Although 3M is best known by consumers for its tapes and other adhesive products, the company calls itself a diversified technology company and produces a wide variety of products and services on the global level.
MMM is higher by nearly 47% over the past 52 weeks, and the stock has a current forward annual dividend yield of 2.5%. Dividends are a powerful reason why 3M is a great wealth-building investment. The company has increased dividends for 55 consecutive years, and over the past 20 years, 3M has delivered a 523% return, a 17% yield on cost, and a dividend increase of 195%.
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As you know, past performance doesn't equal future results, but I fully expect 3M to continue with its stellar performance well into the future. One of the reasons is 3M's constant innovation.
Unlike many companies of its stature, 3M is not content to sit idly by as young upstarts chip away at its dominance. One example of this innovation involves the lowly kitchen sponge.
Believe it or not, sponges are a $415 million-a-year industry just in the U.S. Nearly 70% of American households use sponges or scouring pads for kitchen and general cleanup. 3M controls nearly three quarters of this market with its Scotch-Brite and O-Cel-O brands. The next leading sponge manufacturer, Armaly Brands, which makes Brillo and Estracell sponges, only has 2.3% of the market.
The primary complaint against sponges is that they typically develop a foul odor after just a few uses. This is because they hold decomposing food particles and bacteria no matter how many times they're washed. To counter this objection, a startup called Scrub Daddy has unveiled a new type of polymer sponge that it claims not only cleans better than regular sponges but also doesn't hold stinky bacteria or food particles.
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To maintain its dominance in the sponge business and attract new customers, 3M developed its own innovate sponge, the Stay Clean scrub sponge. The company plans to launch Stay Clean next year by giving away 1 million samples. This kind of constant innovation is why I expect 3M will maintain its dominance as a dividend-producing investment.
Risks to Consider: Overall market risk is at the forefront with a company like 3M. It is highly correlated with the overall stock market, meaning a down market will likely mean a lower 3M price. Always use stop-loss orders and diversify when investing.
Action to Take --> I like buying 3M on pullbacks. I would not buy this high right now; I'd rather wait for the next pullback to the 50-day simple moving average. The technical picture indicates this should occur within the next 90 days. Being patient will allow you to buy this dividend machine at as discount.