Deere Has Two Ways to Win

 | Dec 09, 2013 | 6:00 PM EST  | Comments
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There's an old saying that investing is easy, just not simple to do. Investing is easy in the sense that if you stick to a few simple rules, you can do generally well in the stock market. Where the discipline becomes difficult is in understanding markets and separating the noise from the useful information.

How is investing easy? It's as simple as identifying high-quality companies, buying them at a sensible price, and being patient. It's also easy because if want exposure to equity and don't feel you have the time or energy to devote, you can buy a low-cost index fund. When people start acting like they know more than really know, that's when the mistakes kick in.

Luckily today, the market is giving investors a very easy investment for those who are willing to commit and stay committed. That investment is Deere (DE), the largest manufacturer of farm equipment in the world. At the moment, the company trades for less than 10x earnings and yields 2.4%. In my opinion, Deere is the highest-quality stock in the market today, trading for a single-digit P/E ratio.

History has confirmed over and over that financial setbacks for Deere create opportunities for investors. In 2009, net profit fell to $1.2 billion, from $2 billion in 2008. The stock fell to $24, and over the next several years it rallied to nearly $100. At $85 a share today, the upside may not be as rich as it was during the depths of the market recession, but Deere shares could be worth $140 or more in three years if not sooner.

At the current price of $85, Deere is expected to earn $8.85 per share in 2013 and $8.05 in 2014, according to Value Line. So the stock is basically trading at a forward multiple of 10. For this price, you get one of the most dominant franchise businesses in the world. Deere makes money two ways: from the sale of the product, and then the more lucrative recurring servicing revenue that its franchised dealerships generate.

For over a decade, Deere has generated a return on equity ranging from 20% to over 40%. Revenue has more than quadrupled in the past 10 years. Also, Deere gets more than 40% of its revenue outside the U.S., so the company is a very excellent play on emerging-market growth. Farming and agriculture are key to any growing society and Deere's famous green-painted equipment is well known for its quality. But it's the growing franchise network that really moves the engine at Deere. As the network expands, Deere's competitive advantage continues to grow.

While it hasn't gotten as much buzz as his other recent investments, Warren Buffett's Berkshire Hathaway (BRK.A) became a shareholder of Deere earlier this year when the shares took a dip.

It doesn't get much simpler than Deere. It's a high-quality company trading at a significant discount to the market multiple because the immediate outlook for farming equipment looks weak. Deere's business can be affected by cycles. But during a downturn, the company's franchises continue to pull in profits as owners choose to repair rather than buy. So what you get is a chance to buy the stock on a dip and to profit from the next cyclical upturn.

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