Deere (DE -0.18%) stock is up 167% in the last five years, crushing the performance of the S&P 500 and even the Nasdaq Composite. The stock's run-up is backed by a bottom-line boom as strong agriculture and construction industry performance has supported spending on new machinery and earthmoving equipment.
There are a lot of questions on investors' minds. How long can Deere keep it up? If customers just bought new machinery, why would they lay out more capital in the short term? Is Deere stock overvalued if its profits fall?
Let's put these concerns out in the open to see if the best is over for Deere stock or if there's a better way to look at this blue chip investment opportunity.
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The Deere Smart Industrial strategy
A few years ago, Deere rolled out what it calls the Deere Smart Industrial operating model. At the core of the strategy is a focus on improving performance and saving customers money. The approach goes hand in hand with Deere's Leaps Unlocked strategy, which is centered around automation, autonomy, and artificial intelligence.
Deere is making a big bet on increasingly sophisticated agriculture and construction industries led by technology. Examples include tools and software programs to boost crop yield, harvest at the right time, precision planting and fertilizing, and more.
To support these investments, Deere prioritizes growth by paying a relatively small dividend, which leaves more room for buybacks, research and development (R&D), and operating expenses.
DE Total Operating Expenses (TTM) data by YCharts.
In the chart above, you can see that Deere spends more on R&D than its dividend. In fact, its R&D expenses are up over 30% in the last three years. In the trailing-12-month period, it spent about four times more on stock buybacks than dividends, which is a sign that Deere believes that reducing the outstanding share count and thereby boosting earnings per share (EPS) is a better way to grow shareholder value than paying a dividend. By spending more on buybacks than a dividend, a company is saying it can produce a better return for investors than one-off dividend payments. And for a growing company like Deere, this has certainly been the case.
The lesson here is that Deere isn't investing to capitalize on a particular cycle. Rather, it is putting the pieces in place to support decades of growth by being a technological leader.
The snowball effect
How a company responds to a growth cycle can tell you a lot about where its priorities lie. It's easy to overinvest when times are good, only to open up vulnerabilities when the cycle takes a turn for the worse.
One of Deere's greatest strengths is its management. Deere has done an impressive job setting up the company for long-term growth through its investments while also limiting the damage of a downturn by keeping inventory lean and maintaining a watchful eye over dealer inventories and customer demand.
Deere is an excellent example of how a powerful brand paired with execution can result in a snowball effect. Effective execution opens the door to long-term investments in R&D no matter the market cycle, which allows a company to take market share during downturns through acquisitions or organic growth. Profits that outpace dividend requirements lead to share buybacks and higher EPS, which can support a rising stock price without the stock becoming overpriced. Pair higher EPS from buybacks with earnings growth from operations, and you have a one-two punch that can compound growth and widen a company's lead over the competition.
An investment in quality
There's no denying that Deere stock has been on a tear. And to keep beating the market, Deere is going to have to support future earnings growth by limiting earnings declines during downturns and capitalizing on growth periods.
Given the uptick across the agriculture and construction industries, Deere was going to have a good few years no matter what. But the extent to which Deere has grown profits even past its own estimates is extraordinary. And yet, Deere is reserved enough to know when to pull back, which is exactly what it is doing with its inventory management and production.
All told, Deere stands out as a company that makes good decisions, has a trusted brand, and has the drive to keep making its products better and better. Even if Deere struggles to surpass its record fiscal 2023, it's still a stock worth owning over the long term.
