Background:
I took a value investing class in Fall 2014, aka the beginning of my junior year. For one of the assignments, we were required to pick a stock we thought was “undervalued” and to write an investment thesis about it.
When I say this was a “value investing” class, I mean Buffett/Graham type of deep value investing. I was an econ major and had taken two accounting classes so I had some knowledge about finance, but not much. So for me, this class was a perfect intro into investing since it wasn’t super technical. I enjoyed how I was taught to take a more holistic approach to analyzing companies, which is more applicable in gaining a broader understanding of general business, imo.
The principles I learned in this class have heavily shaped a lot of my current investing habits** – long time horizons, strong brands and management, fair prices, and staying within my circle of competence.
** ...current investing habits when doing individual stock picking. Obviously I don’t have Warren Buffett’s level of intelligence or skillset so I can’t just pick 8 stocks and call it a day. Now that I’ve graduated and am starting to make a little more money, I’m currently in the process of re-balancing the vast majority of my portfolio to diversify across a variety of different companies and funds, albeit slowly (95% still in individual stocks, oops).
Anyway, I thought I’d share one of the papers I wrote to give an example of how a relative beginner can apply general value investing principles, as well as to show, at a surface level, what can actually go into analyzing a stock. Of course this was simply for a letter grade and I procrastinated a bunch, but I still think this is a good change-up from reading a bunch of theory and tips to seeing analysis in practice from the perspective of a novice.
So here is my “4” (3.6-with-lots-of-headers) page long investment thesis on Deere & Company. Feel free ask questions or to rip it apart. I promise you that 20 year-old me will not be mad.
Principles of Value Investing
4 December 2014
Deere & Company (NYSE:DE)
Company Background
Deere & Co is an American corporation that produces agricultural, construction, and forestry machinery worldwide. Blacksmith and inventor, John Deere, founded the company in 1837, starting out by selling small farm tools. Since then, the company has grown into one of the most well known American brands and a leader in the agricultural machinery industry.
Deere operates in three major business segments: Agriculture & Turf, Construction & Forestry, and Financial Services. The Agriculture & Turf segment is Deere’s largest division, generating 77% of total revenues. This means that the success of the Agriculture & Turf segment is crucial for the overall health of the company.
Industry
Deere is in the machinery manufacturing and distribution industry, which includes other companies such as Caterpillar Inc., CNH Industrial N.V., Komatsu Limited, and Kubota Corporation. Market drivers in this industry are changes in population, seasonal weather patterns, state of the economy, and advances in technology. In developed countries, the market is heavily saturated, which explains possible declines in growth. However, the agricultural machinery industry still has a lot of room to expand in developing countries. The future of this industry will be determined by innovation in the US and speedy expansion and growth in developing countries.
Competitive Advantages
Deere is very well positioned business with substantial economic moat due to a number of sustainable competitive advantages. Deere is an industry leader with a high market share, especially in the agricultural machinery sub-industry. Also, it is difficult for new competitors to enter the market due to very high entry costs.
Deere’s long history in American business has given the company massive brand awareness, as shown by the company’s placement on the Interbrand and Forbes most valuable brands listings. Over 150 years of growth and innovation has helped the John Deere brand evolve into a trusted American company that is also changing the face of agriculture globally.
One of Deere’s most crucial, sustainable, competitive advantages is its powerful dealership network and global infrastructure. These elements are key in the long-term growth and scalability of the company in an industry that is looking to quickly branch out to other countries. Deere has already developed a strong presence in many developing nations by establishing the necessary manufacturing plants and warehouses to reach global demand. Further relationships with banks and distribution centers in emerging markets have given Deere a strong base to rapidly expand.
Valuation
As of November 20, 2014, DE was trading at $85.37/share, resulting in a market capitalization of $30.5B. That share price places DE right in the middle of its 52-week range ($78-$94). At a stock price of 9.7x earnings, Deere’s PE ratio is below the industry average of 13.3 and even lower than its major competitors, which all trade at over 16x earnings. Deere’s 5-year average PE is 15.7, which indicates that the company is trading at a discount relative to historical PE.
Over the past 10 years, net profits have seen a growth from $643M to $3533M. EPS has also grown from $2.78 to $9.08. After the 2008 financial crisis, EPS dropped to a 10-year low of $2.06. So from 2009 to 2013, Deere experienced an amazing 45.0% compounded annual growth rate in EPS. Deere’s ability to improve both net profits and EPS in the middle of massively negative macro-event, suggests that Deere’s is significantly undervalued relative to its major competitors. Even priced at a conservative industry average of 13x earnings, below major competitor PE ratios of over 16, Deere would be valued at a fair price of $114/share, a significant increase from $85.37/share.
Reasons for Low Valuation
Even with its great EPS growth and industry leading operating margins, Deere is trading at a significantly lower PE ratio. In my opinion, Deere is definitely undervalued. One reason why Deere is trading at a discount is that industry sales, mostly in large equipment, are forecasted to decrease 5-10% in coming years. Projected decreases in commodity prices and farm incomes are reasons for short-term decreases in sales. Investors may see Deere’s reliance on its Agriculture & Turf division as a weakness in an industry that is very cyclical and subject to macro-changes.
Catalysts and Future
Although forecasted short-term industry sales are bleak, long-term growth looks promising. Year to year price changes are a short-term negative catalyst on the stock price, but in the long run, the market is headed for success. Increases in the worldwide population, which is projected to reach over 9 billion by 2050, will help Deere unlock its true value. A growing population increases the demand for Deere products to help match the increases in overall food consumption. Rapid expansion in developing nations, where Deere already has a strong presence, will require agricultural output to double by 2050. Positive trends toward urbanization point to increases in living standards, which will also help Deere reach a higher valuation. Urbanization will improve Deere’s Construction & Forestry segment, as there will be a great need for roads, bridges, and buildings.
Value Investment
The forecasted downturn in the market may lead to an even better bargain for value investors looking to capitalize on market fears. Deere is a compelling investment due to both quantitative and qualitative factors that have priced the company at a discount relative to industry peers. Deere’s low PE ratio and amazing EPS growth are attractive numbers for those looking to invest. Additionally, the company has high operating margins that lead the industry. Business wise, the company is positioned very well strategically, with many competitive advantages and high market share, in an industry with positive long-term prospects. The world population will inevitably grow, which allow market leaders in the machinery industry to thrive. If Deere can sustain its current position in the industry, small downturns in the market will have no effect on the long-term value of the company.
Another important factor to consider is the management of the company. Deere’s ability to rebound after the financial crisis in 2008, as shown by the 45% CAGR in EPS, shows strength in management, a characteristic of all great companies. Deere has a strong future and should be considered a great value investment.
Submitted March 15, 2017 at 12:08PM by ArrShoe http://ift.tt/2nFcP2V
