Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Deere (DE +2.06%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.
What we're looking for
The graphs you're about to see tell Deere's story, and we'll be grading the quality of that story in several ways:
- Growth: Are profits, margins, and free cash flow all increasing?
- Valuation: Is share price growing in line with earnings per share?
- Opportunities: Is return on equity increasing while debt to equity declines?
- Dividends: Are dividends consistently growing in a sustainable way?
What the numbers tell you
Now, let's take a look at Deere's key statistics:
DE Total Return Price data by YCharts
|
Passing Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Revenue growth > 30% |
62.7% |
Pass |
|
Improving profit margin |
99.7% |
Pass |
|
Free cash flow growth > Net income growth |
(132.6%) vs. 224.9% |
Fail |
|
Improving EPS |
252.2% |
Pass |
|
Stock growth (+ 15%) < EPS growth |
50.3% vs. 252.2% |
Pass |
Source: YCharts. * Period begins at end of Q2 (April) 2010.
DE Return on Equity data by YCharts
|
Passing Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Improving return on equity |
147.8% |
Pass |
|
Declining debt to equity |
(1.8%) |
Pass |
|
Dividend growth > 25% |
70% |
Pass |
|
Free cash flow payout ratio < 50% |
Negative FCF |
Fail |
Source: YCharts. * Period begins at end of Q2 (April) 2010.
How we got here, and where we're going
Deere got off to a hot start, but it was tripped up by falling free cash flow. Over the past three years, the company's free cash flow has dropped through the floor, and now sits in negative territory. That isn't enough to call this stock stale, as Deere earned seven out of nine possible passing grades, and it has a good chance to achieve a perfect score next time around provided it can nudge its cash flow back into the green. This is a strong performance, but can Deere keep up the progress? Let's dig a little deeper to find out.
The construction equipment industry has had to put up with macroeconomic headwinds for some time, despite the generally brightening outlook on display of late. Deere has had to put up with problems such as the severe drought that ravaged the U.S. last year, which would certainly depress demand for harvesting equipment. Deere makes 80% of its revenue from farm equipment, with the rest from the construction market. However, Deere's doing better than sector peer Caterpillar, which has sunk on sluggishness in the mining industry, which is responsible for 41% of its sales. Amid the gloom, one equipment maker that was surprisingly keeping its head above water was Terex. Terex's stock hit a 52- week high in May, but plunged last month over problems with two of its divisions, construction equipment and material and port handling solutions. In light of these problems, Deere might be poised to outperform its peers, particularly if farmers enjoy better yields this year than they did in 2012.
Many heavy equipment companies are struggling to produce revenue growth, but Deere expects to grow its equipment sales by 6%, mainly due to an upsurge in sales across South America (particularly in Brazil, which produced net income of roughly $3.3 billion in the 2013 fiscal year). On the other hand, Deere's construction and forestry sales are projected to fall by 5% during the year, but this shouldn't have a strong adverse effect on Deere's sales growth. In 2012, most of its revenue -- $27.1 billion -- was from agriculture and turf equipment, while the construction and forestry segment pulled in $6.4 billion.
Looking forward, Deere's sales are likely to rise further as the company continues to increase its exposure to high-growth countries like Brazil. Moreover, if the company continues to expand its agriculture and turf business, this could also lead to an increase in profit margins in the coming years. On the other hand, the recent sociopolitical instability in Brazil reminds us to never get too complacent when investing in overseas opportunities. Additionally, a strengthening U.S. dollar could crimp international sales growth.
Putting the pieces together
Today, Deere has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.
