ADM's Earnings Growth Slowdown Creates Buying Opportunity

Mar. 9.12 | About: Archer Daniels (ADM)

Although Archer Daniels Midland Co. (NYSE:ADM) reported a challenging second quarter for fiscal 2012, a strong balance sheet and strong cash flows support dividend growth. Furthermore, a growing world population validates the thesis that demand for quality foods, feed ingredients for livestock, alternative fuels and environmentally friendly alternatives to traditional chemicals are all opportunities for long-term growth. Also, the company's strong financial condition positions it for future growth. The company is building out its infrastructure in what they believe to be exciting markets in South America and Eastern Europe.

With interest rates hovering near all-time lows, investors needing income are faced with very limited choices. The traditional high yield available from bonds and other fixed income vehicles are no longer available to meet the goals of retirees needing income to live off. Moreover, it is almost a certainty that today's low yields are not adequate enough to fight inflation. Consequently, there is a growing investor interest in dividend paying common stocks, especially those that have a long record of increasing their dividend every year.

Growth and dividend income stocks are defined as companies that provide the opportunity for long-term capital appreciation and a growing dividend income stream over time. Both, capital appreciation and dividend growth will generally be consistent with the company's average earnings growth, assuming there is a strict adherence to sound valuation.

Archer Daniels Midland Co.: Large-cap Growth at an Attractive Price

About ADM: (Directly from their website):

For more than a century, the people of Archer Daniels Midland Company have transformed crops into products that serve vital needs. Today, 30,000 ADM employees around the globe convert oilseeds, corn, wheat and cocoa into products for food, animal feed, industrial and energy uses. With more than 265 processing plants, 400 crop procurement facilities, and the world's premier crop transportation network, ADM helps connect the harvest to the home in more than 160 countries.

Earnings Determine Market Price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph, the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Archer Daniels Midland Co.: Historical Earnings, Price, Dividends and Normal PE Since 1998

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Performance Table Archer Daniels Midland Co.

The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two components of total return, capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.

When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 4% capital appreciation, long-term shareholders of Archer Daniels Midland Co. would have received an additional $26,656.82 in dividends that increased their total return from 4% to 5% per annum.

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The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 1998.

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A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Archer Daniels Midland Co. is .23, which is historically low.

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To use the interactive tool, click here.

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1.The rate of change (growth rate) of the company's earnings

2.The price or valuation you pay to buy those earnings

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance. Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. Archer Daniels Midland Co. is clearly an industry leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, Archer Daniels Midland Co. represents an opportunity for growth at a reasonable price.

The important factor is that Archer Daniels Midland Co., with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 15 leading analysts reporting to Capital IQ forecast Archer Daniels Midland Co.'s long-term earnings growth at 5.7%. Archer Daniels Midland Co. has medium long-term debt at 30% of capital. Archer Daniels Midland Co. is currently trading at a P/E of 11.4, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Archer Daniels Midland Co.'s True Worth™ valuation would be $57.75 at the end of 2017, which would be a 14.1% annual rate of return from the current price.

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Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Archer Daniels Midland Co. to an equal investment in 10 year Treasury bonds, illustrates that Archer Daniels Midland Co.'s expected earnings would be 6.1 times that of the 10 Year T-Bond Interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

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Summary & Conclusions

This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it's imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

Archer Daniels Midland is both a Dividend Champion and Dividend Aristocrat that has raised their dividend for 36 consecutive years. Historically, the company has an excellent record of earnings growth to back up its dividend record, but does go through the occasional bouts of cyclicality. This happened from 1999 to 2005, and although earnings growth has been relatively flat since 2008, Archer Daniels Midland has nevertheless been a profitable business. Furthermore, even though earnings are going through a flat period, we do believe that at its current price, Archer Daniels Midland's common stock represents an excellent long-term value for the prudent investor seeking a growing dividend income stream from a quality company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The opinions in this document are for informational and educational purposes only, and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.