Deere: A Word Of Caution

| About: Deere & (DE)

Deere (NYSE:DE) is a legendary company that provides equipment for agriculture, construction and forestry. I have recently read many articles praising the company and recommending investors to buy shares of Deere. There are indeed good reasons for an investor to consider purchasing Deere shares.

First of all, the company has exhibited exceptional performance in the past. Only in the last decade, the company increased its earnings per share from $1.32 to $7.63 (data from, which equals to annual compound growth in EPS of 19%. This is an exceptional performance that very few companies can achieve and those who achieve it are mainly new companies involved in a nascent, high-growth market. For a company 175 years old this is really phenomenal. For instance, in the last 10 years, Wal-Mart (NYSE:WMT) and Coca Cola (NYSE:KO), which are both fantastic companies, achieved an annual compound growth of EPS 10% and 9%, respectively.

Another good reason to purchase Deere shares is the latest filing of Berkshire Hathaway, which revealed that it purchased almost 4,000,000 shares of Deere. As the performance of Warren Buffett is more than sufficient to most of us, we can simply follow him on this investment, which in any case looks promising.

However, I would like to add a word of caution for Deere. First of all, it is a very highly cyclical company. This means that it will normally outperform S&P in a bull market but it will markedly underperform S&P in a bear market. Indeed, in the great financial crisis 4 years ago, Deere plunged 73% in just 12 months, from $94 to $25, while S&P fell 57% during the same period. In another example, in the market correction of summer 2011, Deere fell 40% while S&P just lost 19%. As a highly cyclical company, Deere experiences a pronounced decrease in earnings during recessions. For instance, in 2009, it realized EPS that were 56% lower than the earnings of the previous year and were equal to the trailing EPS of mid-2003.

Another weak point of Deere is its increasing debt, which has been mentioned in a previous article (here). The net debt is about $43 B, which is 16 times current earnings. This is a remarkably high level of debt that is rarely met in companies with a competitive advantage and will pronouncedly burden the company whenever a recession emerges, thus enhancing the plunge of the earnings and of the stock price.

Colin Lea (here) noted the extremely high return on equity (ROE) of Deere, which is about 45%. This indeed reveals the exceptional performance of the company. However, an investor who is considering to purchase Deere shares now should only be interested on the yield of the current investment, which is equal to the reciprocal of the ratio of P/E and equals ~9% right now (with the stock at $84). The difference between ROE and earnings yield is simply due to the fact that Deere trades at almost 5 times its book value, which means that today's investor pays really high for the stock and hence will realize a much lower yield than the ROE.

Finally, the fact that Warren Buffett bought the stock does not mean that everyone should follow him. First of all, he bought his shares at a 5%-15% lower level, somewhere between $70 and $80. In addition, it is well known that the legendary investor has a very long perspective (even though he is 82 years old) and tends to keeps his shares for many years (ideally forever), whereas some investors may panic at a temporary drop of 40% (like last year's drop).

To sum up, Deere is a great company with an exceptional past performance. However, in market corrections, let alone recessions, this stock is not recommended for investors sensitive to heart attacks. I believe there is an imminent, significant correction to be realized in the market, which will send indices about 10% lower. I find this correction very probable due to the fiscal cliff and also because I do not think that corporate earnings can markedly increase next year given the restricted growth in US (due to imminent spending cuts and taxes), Europe (austerity measures) and China (decelerating economy). Therefore, I would wait for this correction to occur and then I might buy some shares of Deere.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.