Deere (DE) looks cheap today

Deere

DE has the 3 big things I like to see: 1) A consistent, multi-decade history of mouthwatering economics, 2) a dominant, wide-moat position in a critical industry that is unlikely to be disrupted (meaning those past mouthwatering economics are likely to continue into the future), and 3) an attractive price.

Take a look for yourself at DE over the past 20 years: High ROE, solid growth, decreasing share count, etc. Deere is an iconic brand, and the undisputed king of agricultural machinery. They also have decent, but not nearly as good, segments in construction, forestry, and home lawn care. The global need for those industries is not going away anytime soon.

Now, against my better judgment, I’m gonna nerd out on price…

As far as price, depending on the discount rate you use, DE is priced for basically ZERO growth. Specifically, at an 11% discount rate, assuming zero growth, DE would be worth about $82.63. DE is currently selling for $81.60. I don’t really use DCF’s to be an exact valuation, but more of a sanity check…that’s why Buffett says if you need to use a detailed DCF analysis, then the stock isn’t cheap enough.

I just played around with a reverse DCF (I like reverse DCF’s much more than normal DCF’s), inputting the current stock price, and fiddling with reasonable range of discount rates, a 0% perpetuity growth rate after year 10, looking to see what growth rate is currently “baked in” to Deere’s current price. The results were this: depending on a range of discount rates between 7% and 13%, DE is basically priced at an expected future EPS growth rate between -6.2% and 2.57% over the next 10 years, and assuming 0% growth after those 10 years.

Pardon, the silly finance math, the real point here is that anyone who knows DE knows that DE is going to grow EPS at more than 2.57% annualized over the next 10 years, and will probably keep growing well after that. I don’t know what rate DE will grow at…maybe 5%?, maybe 8%?, maybe more? But, I do believe that, in the long run, the probability is that it will be way more than 2.5%...therefore DE is underpriced. You don’t need super exact estimates when a DOMINANT business is this cheap…just like Buffett says…you just need to recognize a really WACKY low baked-into-the market-price growth assumption. 

Perhaps ironically, I actually expect DE’s EPS to drop over the next couple years since their margins and profitability are SO high right now…you can argue that DE’s ‘normalized earnings are closer to $7 per share (so we’re still talking a “normalized” PE under 12) but over the long run, say 10 years, I can’t see an annualized growth rate under 4%-5%. Otherwise stated, I can’t see DE having normalized EPS under $12 in 10 years…and I doubt that along that growth trajectory, DE won’t sell for 14x normalized earnings or more, at at least few points along that road. What THAT means, to me, is that it’s really hard to in vision a world where DE stock grows at LESS 7% annualized or more, at some point, over the next decade + you get your nearly 3% dividend as well. So maybe a total return around roughly 10% over the next decade…which is likely going to be much higher than the S&P 500.

Sorry for the long-winded pitch. At the end of the day, this seems to me to be another asymmetrical long-term bet, especially compared to the S&P 500. 

DE to outperform.