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Deere Divergence

By Stephen D. Simpson, Simpson, – Updated Nov 16, 2016 at 1:09PM

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Business is strong, but the stock is not. Is Wall Street assuming the worst?

Deere (NYSE:DE), the company, has been running like a deer. Deere, the stock, has been running like a duck... and a decoy at that. After enjoying a strong 2003, the stock has gone basically nowhere in the past 18 months, even though business has been pretty good.

Revenue in the second quarter climbed by 13%, with a 13.6% increase in equipment sales. Better still, there was strength in both pricing and volume for the quarter. The efficiencies gained with greater production levels and the higher pricing helped Deere see improved margins and a 19% jump in operating income. A few lines down, a better tax rate led to a 27% improvement in net income.

Agricultural sales were up 17%, and construction/forestry sales were up 28% on stronger demand. The same cold and wet weather that hurt Lowe's (NYSE:LOW), though, hurt the commercial/consumer business, and sales were down 6% in part because of poor sales of consumer lawn equipment.

So what's the deal with the stock?

With this quarter in the books, Deere has a trailing P/E below 10 -- more or less in line with its historical growth rates in book value and owner earnings growth. Given that companies like Deere almost always trade at some premium to those sorts of growth rates, Wall Street clearly believes there are some issues here.

I suppose I can understand some of Wall Street's worries. After all, this business is heavily tied to agriculture, and spending on agricultural machinery is a function of crop yields, crop prices, economic conditions, and government policies toward farming and farm subsidies (both here and abroad), not to mention competition. Those are a lot of variables to manage.

But I'd argue they're the trees that obscure the forest. Here are a few facts: There are a lot of people on this planet, and most of them are going to make even more people. People like to eat, and if there are more people, then more food will be needed. If more food is going to be produced from less land (remember, those new people need a place to live and work), agriculture will have to become increasingly mechanized and efficient.

Get the picture?

I just can't help foreseeing a long-term future where there is ongoing demand for products like tractors and combines and whatnot. I'll grant that competitors like Caterpillar (NYSE:CAT), CNH Global N.V. (NYSE:CNH), and AGCO (NYSE:AG) will be ever-present and nipping at Deere's heels, but Deere has been there and done that before.

But that doesn't mean I'm wildly excited about the stock. While I think Deere, the company, has a good future ahead of it, the stock is a different story. A company with a history of 9%-10% growth trading at a P/E of 9-10 just doesn't do it for me. Were I to purchase such a consistent slow-grower, I'd want a P/E more like 5 or 6 -- but that's just me.

For more on dear ol' Deere and related companies:

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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Stocks Mentioned

Caterpillar Inc. Stock Quote
Caterpillar Inc.
CAT
$164.24 (-3.70%) $-6.31
Deere & Company Stock Quote
Deere & Company
DE
$334.22 (-3.44%) $-11.91
First Majestic Silver Stock Quote
First Majestic Silver
AG
$6.73 (-8.31%) $0.61
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
LOW
$188.13 (0.01%) $0.01

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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