In this short article, I will show why you can now buy Deere & Company (DE) at a price that only apparently is much higher than back in 2009.
According to Warren Buffett, there is a test every investor should run before buying a stock: You should figure out whether the company creates or destroys value, i.e. whether management has been able, over longer periods of time, to transform every dollar of retained earnings into at least one dollar of market value.
Let's run this test for Deere:
Retained earnings 1/2009: $10.67 billion
Retained earnings 7/2013: $19.03 billion
Difference: $8.36 billion
Market capitalization 1/2009: stock price $35 x 422.67 million shares outstanding = $14.8 billion
Market capitalization today: stock price $82 x 382.85 million shares outstanding = $31.4 billion
Difference: $16.6 billion
Deere meets the requirements: its management has transformed every dollar retained into more than a dollar of market value.
But there is another conclusion to draw from this exercise:
Now we know how Mr. Market thinks about Deere's value compared to January 2009. He believes the business today is worth $8.24 billion (16.6 less 8.36) more than during the peak of the market panic, which translates into $21.5 per share. At about $60, the stock would be as cheap as in January 2009, as we would pay only the sum of the then stock price of $35 and the earnings retained since then.
In other words: We can buy Deere & Company now at a price which corresponds to the stock price of December 2009, because at about $54 the market capitalization was $8.36 billion lower than today.
Just to feel a bit more sure about our results, let's now compare the Price/Earnings Ratios:
2013 (consensus estimate)
Considering that in January 2009, we were right in the middle of the stock market panic and that 2009 EPS was sure to fall steeply, the current PER looks even cheaper.
I hear your objections: The stock market trades the future. Retained earnings do not automatically translate into added value, hence the necessity to run the above test in the first place.
So what about Deere's future? Does it really look bleaker than back in January 2009? Will EPS shrink by more than 50% like it did from 2008 to 2009? Analysts estimate that there will be little growth over the next few years, but not a major profit reduction. Consensus EPS estimates for 2014 and 2015 are $7.97 and $8.08 respectively. Based on these estimates, analysts pin fair value to about $85/share, not far from where the stock trades right now.
In my opinion, this is due to the typical short-term focus of Wall Street analysts. There is no discussion whatsoever that over the long run Deere will grow its earnings again. The company is expanding internationally, the world's demographics provide strong tailwinds: as more and more people move into cities, in the future, a smaller agricultural workforce will need to produce more efficiently. Deere's brand is one of the strongest in the business and the company is as innovative as ever. Moreover, the company buys back its own stock, providing some extra guarantee for rising EPS figures in the future. If the stock stayed at the current price level and Deere allocated all of its earnings to share buybacks, EPS would rise by about 10%/year!
Over the long run, I see Deere trading back at its once normal fair value PER of about 15. Even if it takes 3 years to get back there and even without any EPS growth, the stock would trade at about $120 in 2016, providing a nice compounded annual return of 13.5% plus dividends.