TheÂ ModernGraham approachÂ to investing has multiple layers to it. Â Regular readers will be familiar with the first two steps; the first is to determine if the company is suitable for the Defensive Investor or the Enterprising Investor, and the second is to compare the price to theÂ intrinsic value through quantitative analysis. Â The next step in the analysis is to review the company’s management and other qualitative factors to determine how the company may compare to other companies that pass the first two steps. Â In this Company of the Week series, we will delve into more detail about a specific company that performed well in the first two areas. Â This week, the company chosen, Deere & Company, is one of the most undervalued out of all 250+ companies in the ModernGraham database and was recently featured as one ofÂ April’s 5 Undervalued Companies for the Defensive Investor.
Results of Recent Valuation
Feel free to reviewÂ ModernGraham’s latest valuation of Deere & CompanyÂ in detail, or read this summary:
Deere & Co. is an excellent company that is suitable for either the Defensive Investor or the Enterprising Investor. Â The only requirement for either investor type that the company does not meet is the PB ratio. Â As a result, value investors following a ModernGraham approach based on Benjamin Graham’s methods should feel very comfortable proceeding with further research into the company as well as other opportunities, such as through a review ofÂ ModernGraham’s valuation of Caterpillar Inc. (CAT). Â From a valuation perspective, the company appears to be significantly undervalued, having grown its EPSmg (normalized earnings) from $3.68 in 2010 to an estimated $7.62 for 2014. Â This demonstrated level of growth more than supports the market’s current implied estimate of 1.86% earnings growth, leading the ModernGraham valuation model to return an estimate of intrinsic value that is well above the market price.
Price trend compared to the market
In the following chart, it is clear that over the last five years Deere & Company has outperformed the market, but in the second chart it is clear this trend has not been true in the last year. Â While Intelligent Investors will know that price trends are not determinative of value or opportunity, they can be helpful in comparing Mr. Market’s behavior toward the company with the valuation. Â It is easy to see that Mr. Market does not view the company quite as favorably as he did a few years ago. Â Now, despite the company outperforming the market over the last five years, it does appear to still have upside, as explained in the summary above.
Earnings Per Share
The next chart shows Deere & Company’s earnings over the last 30 years. Â Two things stand out: Â (1) Â the company’s earnings have been strongly rising despite a couple of bumps in the road, and (2) the earnings have skyrocketed in the last few years. Â This is illustrated also by the rise in EPSmg (normalized earnings) from $3.35 in 2009 to an estimated $7.62 for 2014. Â One would definitely like to see this trend continue, but it probably isn’t realistic to expect it to happen long-term, given the fact the growth rate in that time period is over 20% per year. Â However, according to the ModernGraham valuation model, the market is only implying a growth rate of 1.86% based on today’s price. Â So growth could slow considerably and still be better than the market is expecting.
Dividend Rate & Yield
Dividends are a very important part of any analysis into a company, as they not only indicate management’s willingness to return value to shareholders, but they also indicate an opportunity for the Intelligent Investor to gain a return on the investment outside of capital appreciation. Â In the next chart, we see that Deere & Company’s dividend has increased very significantly in the last ten years, and the company still demonstrates a very strong dividend yield of 2.19%.
Price to Book
This final chart demonstrates the potential value by showing the company’s price to book ratio over the last 10 years. Â As you can see, the company is trading at a low Price to Book ratio when compared to the last five years. Â In addition, the only times in the last 10 years the price to book was lower was during the great recession and during a brief period from 2005-2007. Â This alone is not a strong indicator of value, but used in conjunction with intrinsic value estimates and detailed analysis, it can help show again that the market may be undervaluing the company. Â At the very least, the market is not treating it the way it did in the past.
To me, Deere & Company appears to be a very intriguing opportunity for value investors. Â The company qualifies for both Defensive Investors and Enterprising Investors, and the quantitative analysis using one of Benjamin Graham’s formulas indicates the company is significantly undervalued. I think there are much fewer concerns about this company than many others. Â I also believe that given the rise in the earnings, the strong dividend yield, and the low PB ratio, it may only be a matter of time before Mr. Market brings the price up. Â The company passes the initial tests with flying colors, and I’d be very interested to hear readers views regarding any qualitative analysis regarding the company through comments on this post.
Warren Buffett has promoted looking at some key management tenets, and I’d like to leave it up to readers to discuss how Intel fulfills (or fails to fulfill) these qualities. Â Please discuss the following in the comments below:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the company have favorable long-term prospects?
- Is management rational?
- Is management candid with shareholders?
Disclosure:Â Â The author held a long position in Deere & Company (DE) but no other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.