RealMoney Silver - ADM Is Sprouting Good Returns

ADM Is Sprouting Good Returns
By John Reese
RealMoney.com Contributor
1/8/2008 3:57 PM EST

About a year ago -- Feb. 6, 2007, to be exact -- I wrote about several ethanol plays. I would like to revisit one of these now, as it remains a favorite of the guru strategies I follow, even though -- or perhaps because -- its stock price has done so well since I reported on it.

The company is agricultural giant Archer Daniels Midland (ADM) , which has revenues of $44 billion a year and counts 27,000 employees on its payroll. The ethanol market has not done too well recently due to excess supply, but you would never know it from Archer Daniels' stock price. When I wrote about it in February, it was trading at $33.60. Today, the stock trades at about $45, an increase of about 35% in less than a year.

The reason the market has responded so favorably to Archer Daniels is, quite simply, that the company has performed well. This is no one-trick pony, to use a time-worn cliché. While it is the largest domestic ethanol producer, according to Morningstar, it is also the world's largest corn processor (corn is used to make ethanol, animal feed, et al.), a maker of biodiesel and natural plastics products and a major processor of oilseeds. It also manufactures food additive ingredients, used in a wide range of products that include soft drinks, baking powder, flour and chocolate.

All of this has attracted the attention of two guru strategies -- those I base on the writings of James P. O'Shaughnessy and Peter Lynch. Let us first look at why the O'Shaughnessy strategy likes this company. The first requirement of the strategy is that the company has a market capitalization of at least $150 million; Archer Daniels is way over this at $29 billion. An important criterion is that earnings have grown consistently during the past five years. This holds true for Archer Daniels, whose earnings per share have gone during the past five years from 70 cents to $3.30 and have increased each year without interruption.

Another important criterion is the price-to-sales ratio, which needs to be below 1.5 for this strategy to remain interested. This ratio is a way of measuring how much you are paying for sales. Archer Daniels' P/S ratio is a very impressive 0.61. The final criterion requires that the relative strength of the company be among the top 50 of the stocks screened using the previous criterion. Archer Daniels' relative strength is a solid 85, putting it in the top 50.

My Peter Lynch-based strategy also likes Archer Daniels. Its most famous criterion is the PEG ratio, which looks at the P/E ratio relative to the company's growth rate. Archer Daniels' P/E ratio is now 13.39, while its growth rate is 47.71%, based on the average of the three-, four- and five-year historical EPS growth rates. This produces a very impressive PEG ratio of 0.28. A PEG ratio of 1.0 or less is acceptable, and anything south of 0.50 is great. I should note that analysts expect sales growth to temper in the future, but even so, the stock seems priced low enough now to be favorable.

Another criterion worth considering is inventories relative to sales. These should increase at about the same pace; such lock-step increases are an indication management has inventories under control. There has been an increase in the past year of inventories relative to sales, but the increase is slight and acceptable.

Archer Daniels is a giant in its industry, is engaged in the promising market for ethanol, and has a number of other markets it addresses. In its agricultural niche, it is diversified and has dominant market positions. And, of course, two guru strategies found a number of aspects of the company's financial performance and stock price to make them happy. Though the stock has moved up nicely within the last year, it appears to still have room to sprout even further like corn in season.