Warren Buffett Just Bought 5% of This Farm Equipment Company -- Should You Buy in, too?
NEW YORK (TheStreet) -- Warren Buffett recently disclosed 5% ownership in Deere & Company (DE) - Get Report. He used a special non-disclosure rule to hide the increased position he was building in 2014 to ward off would-be copycat investors. What makes Deere & Company so valuable that Warren Buffett would resort to secrecy to build his holdings?
Deere & Company was founded in 1837. Since then, it has grown to become the largest farm equipment manufacturer in the world. The company is known for its high quality tractors, construction equipment, mowers, and other farm machinery. Deere & Company has been rewarding shareholders for decades. The company has paid steady or increasing dividends since 1987, giving it a streak of 28 consecutive years without a dividend reduction. Deere & Company is a high quality business with a price-to-earnings ratio of just 10.8 and a dividend yield of 2.7%. As a result, it is a favorite of The 8 Rules of Dividend Investing.
Deere & Company operates in 3 business segments: agriculture and turf, construction and forestry, and financial services:
- Agriculture and turf: 41% of operating income
- Construction and forestry: 23% of operating income
- Financial services: 36% of operating income
Despite being the most profitable segment, agriculture and turf is seeing weakness right now in its sector. Agricultural equipment sales are highly cyclical. We are currently in a down cycle due to low grain prices. When grain prices recover, the agriculture and turf segment will see profits rise rapidly. In 2014, Deere & Company generates a full 70% of operating income in the agriculture & turf segment. This shows how profitable the segment can be when grain prices are high.
Buying At The Right Time
The drop in grain prices makes Deere & Company a timely buy. The company's low price-to-earnings ratio shows that Deere & Company is trading at cyclically low prices. Patient shareholders will likely see a rise in both the company's earnings and price-to-earnings ratio when grain prices rise. When both earnings and the price-to-earnings ratio rise, investors see large gains.
During the period from 2007 to 2009, Deere & Company's stock traded at a price-to-earnings ratio of around 15. The stock is currently trading at a price-to-earnings multiple of just 10.8.
Diversifying To Reduce Cyclical exposure
Deere & Company's management has expanded the business into lines that are uncorrelated with the company's primary agriculture and turf segment. The construction and forestry and financial services segments together generated 59% of operating income in the most recent quarter.
The construction and forestry segment manufactures equipment for use in both construction and forestry (as the division's name would suggest). Both the construction and forestry equipment industries are cyclical, but they do not follow the same pattern as the agricultural equipment industry. When agriculture sales are down, construction sales may very well be up, which helps offset the negative effects of being in a cyclical low.
Deere & Company's financial services segment also helps to diversify the company's income away from the agricultural cycle. The financial services segment helps farmers finance their purchases. The resulting interest income stream is relatively steady despite the farming business cycles. This more stable income gives Deere & Company steadier cash flows than they would have without the segment.
Growth Prospects
Deere & Company has seen very solid growth over the last decade. In the last 10 years, the company has compounded earnings-per-share at 12.7% a year and dividends per share at 15.4% a year. The company's 15.4% dividend compound growth rates means dividends have been doubling every 5 years. Deere & Company has a payout ratio of just 22%; the company's conservative payout ratio means the dividend is safe despite cyclical downturns.
That said, and there is no getting around it, 2015 will not be a growth year for Deere & Company. Long-term dividend investors will likely see double-digit dividend growth over the next several years, however. Deere & Company makes an excellent investment for patient investors who don't look at one year of performance, but instead see the long-term growth picture. This is likely why Warren Buffett has chosen to own 5% of Deere & Company.
Deere & Company's management is very shareholder friendly. In addition to paying steady or increasing dividends since 1987, management has aggressively repurchased shares over the last several years, further benefitting shareholders. Deere & Company ranks highly using The 8 Rules of Dividend Investing because of its high long-term growth rate, long dividend history, low payout ratio, and low price-to-earnings ratio.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
