Warren Buffett's Berkshire Hathaway Inc. increased its stake in Deere & Company (NYSE:DE)in the fourth-quarter of 2014, and he subsequently affirmed that he, and another manager, had been buying the stock for the investment firm. The buying has all the hallmarks of the kind of move on which he has built his career. The maker of tractors and other machines is an American icon, operating with a strong competitive moat, in a industry that -- as long as Homo sapiens require food -- isn't going to disappear. Case closed? Should you just follow the sage of Omaha into the stock and reap the benefits for years to come?
Before you rush in, let's look at why Buffett might have bought the stock, and what will move shares going forward.
Buffett 's Berkshire buys Deere stock
Berkshire Hathaway's latest 13F filing with the SEC reveals the company held 17.1 million shares of Deere as of the fourth quarter --representing more than 5% of Deere's shares outstanding. The SEC allowed Berkshire Hathaway to build the position secretly.
Buffett has a well-known investing rule to be "fearful when others are greedy, and be greedy when others are fearful." At least the second half of that aphorism seems to apply to Deere. A chart of Deere's stock price versus the S&P 500 in recent years suggests the market is indeed fearful of Deere's declining agricultural machinery sales and the crop price outlook.
Moreover, Deere recently reported a whopping 19% decline in net sales in the first quarter, and guided toward a full-year net sales decline of 17%. As this Motley Fool article outlines, the earnings report was probably better than the headline numbers suggest, but analysts' median price target remains at $86 -- some 5% below the current $90 stock price.
The analyst community is fearful; Berkshire Hathaway is buying. It's an iconic American brand; Berkshire Hathaway is buying. It's an industry with obvious end-demand prospects; Berkshire Hathaway is buying.
Deere's return on capital employed (which many believe to be the Holy Grail of Buffett's investing philosophy) has been in the midteens for much of the last decade; Berkshire Hathaway is buying. Is it time for you to buy?
It's all about prices
The rationale appears to be clear: Buy Deere when it's out of favor, wait for the soft commodity cycle -- in Deere's case, principally crops such as corn, wheat and soybeans -- to turn, and enjoy the upswing. Before deciding, though, it's worth pausing to reflect on how the cycle typically works for Deere.
Essentially, Deere's sells more agricultural machinery when farmers make more income, and farmers tend to make more money when crop prices are higher. Of course, simple laws of supply and demand dictate crop prices are higher when supply is relatively lower than demand. This could be caused by many factors, including higher crop yields and/or more acreage harvested.
Indeed, observant readers will have noted (in the first chart) that Deere starts to underperform the S&P 500 when crop prices turn downward. In a sense, investing in Deere is partly a bet on crop prices rising, and it's hard to conclude that Berkshire Hathaway would have bought Deere if Buffett didn't think crop prices would go higher over time.
Potential investors will be cheered by the fact that Deere's management is on record as stating that after two years of exceptional crop-producing weather, "normal" crop-growing weather would see crop prices rise and "be supportive of cash receipts" for farmers.
Should you follow Buffett?
All told, Deere's prospects lie with prices for crops such as corn, wheat, and soybeans. If you think they are going higher over the long term, then there is a strong case for following Buffett into the stock
However, one caveat needs to be considered. Much of Buffett's record as an investor suggests that if crop prices fall further, and take farmers' income and spending on Deere machinery down with them, then Buffett could buy more Deere stock. Arguably, Buffett's investing strategy isn't so much buy and hold as it is buy and buy some more.
In other words, don't buy Deere unless you can deal with some near-term risk. It could get a lot worse for crop prices and Deere before it gets better. And keep an eye on the weather.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.