Here Is The Price I'll Buy Deere Stock If It Keeps Falling

Introduction

Whenever possible I always like to start my articles by reviewing any past coverage I've had of a stock. In Deere's (NYSE:DE) case, I have written on it three times previously, but they were all more than 3 years ago. I first warned investors about Deere's cyclical downside risk with a "Sell" rating article titled "How Far Could Deere Fall?" on January 24th, 2018. In that article, I suggested Vanguard Utilities ETF (VPU) was a better alternative until Deere's price came down. The following year I wrote another "Sell" article, keeping the same rating on Deere stock and explaining a rotational strategy for investors who really liked Deere's business, but wanted to avoid a big drawdown and purchase more shares at a lower price in the future. Then a few months later on May 22nd, 2019, I wrote an article titled "Here Is The Price I Will Consider Buying Deere". In that article, I suggested that investors who may have sold the stock after my previous warning articles could rotate back in. Here is how Deere performed compared to VPU from my first sell article until then.

And here is what I had to say in the conclusion:

The rotational strategy I suggested for Deere shareholders back in January 2018 has worked out well, allowing those shareholders to gain over 30% more shares for free if they rotate back in now and hold for the long term. For those investors interested in potentially buying Deere shares at the best price, below $86 is where I would aim to make a purchase.

So, I was writing from the perspective of two different potential shareholders. One who previously owned the stock and sold due to the risks back in early 2018, and wanted to gain some free shares while lowering their risk. And those, like me, who were waiting to buy the stock with a margin of safety. Deere fell far enough for the rotational strategy to work perfectly, but it never hit the $86 I was looking for in a downturn. It bottomed at about $106 when the federal government and central bank came to the rescue in March 2020. Investors who rotated back in on May 2019, have done very well, though.

Despite Deere stock's fantastic rise, I haven't felt particularly moved to warn investors about its downside dangers because the economy has remained pretty strong, and fuel prices have remained pretty high. Now that interest rates are significantly higher, I do think risks to the stock price have risen. The purpose of this article is to at least let investors know what has historically happened to Deere's stock price during downturns, so they are aware of what could realistically happen in the future. I will also share the price at which I'm aiming to buy Deere stock this time around if there is a serious downturn.

Historical Earnings Cyclicality

The first thing I always check with any stock is the historical earnings cyclicality. The reason I check this first is that if earnings are deeply cyclical, instead of basing my analysis on earnings (which can fluctuate a lot and give off false signals) I focus on historical price cyclicality and the wider business cycle.

I generally consider earnings growth declines of -50% or more to be deeply cyclical. Deere experienced two downcycles during the past twenty years when earnings growth fell between -40% and -50%. This is right on the edge of my -50% threshold, but there were historical downcycles before these that were deeper than -50%, so I have decided to treat this as a deep cyclical business. And, I think this makes even more sense to take this approach this time around given the huge earnings upcycle they have experienced since the COVID pandemic. Usually, these sorts of big upcycles are followed by bigger than normal downcycles. It's highly likely that if investors use recent trailing earnings to value the stock they will buy the stock at too high of a price during the initial stages of a downcycle.

So, I will treat Deere as a deeply cyclical business and base my entry point on the stock price declines of previous historical downcycles.

Previous Historical Downcycles

I like to use history as my primary guide for what is likely to happen in the future. I've found that about 80% of the time it is a reasonably good guide, and, if nothing else, I am at least aware of what is possible with the stock.

As you can see from Deere stock's history, it has regularly been subject to stock price declines of -50% or more during recessionary periods. The 2008 recession was particularly bad with a -70% decline, and the 2018-2020 downturn/recession was cut short by massive stimulus from the government, otherwise it probably would have had another -50% decline.

As we can see in the FAST Graph above, Deere has experienced a huge earnings upcycle, essentially doubling earnings in 3 years' time. This is almost certain to result in some sort of downcycle, but it's very difficult to know how deep the downcycle will be. I think there is an extremely high probability the stock price falls at least -35% off its highs, and a decently high probability it falls at least -50% off its highs because one has to assume the last three years of boom times have pulled forward at least some future earnings, which will lead to a "bust".

Historical Returns of This Strategy

My theory when it comes to valuing high-quality, yet deeply cyclical businesses, is that if the market valued a stock a certain way in the past, then it is likely to value it similarly under similar conditions in the future unless something has dramatically changed with the business. While Deere's business is always changing over time, I don't think anything has dramatically changed enough for the market to treat it differently. So, I figure that if the market was willing to pay $450 for Deere stock near its recent peak, then at some point in the future it will do so again. Making that assumption I can estimate what my returns will be when buying at certain points off those highs. Usually, for deep cyclical stocks, I typically buy them when they are about -50% off their highs and take profits after making new highs for a 100% gain. The only question is how long it might take for this process to happen. Again, I let history be my guide.

I shared the following table and explanation in my last Deere article.

"The table below shows the results one would have had they invested after a -50% decline in price during Deere's previous downturns, and then sold after the price recovered its old highs. The returns in the table do not include dividends. I annualized the returns and then compared them to the S&P 500 if bought and sold on the same dates, annualized. The goal is to see if historically buying after a -50% decline would be an alpha-producing strategy, so the last column is the alpha produced by the investment annualized relative to the S&P 500. All the percentages should be treated as estimates and are based on the approximate months held. If one buys after a -50% decline and sells after the stock makes a full recovery, it produces a +100% simple return, so that is the simple return for each of the investments in the table below."

Since 1973 Deere stock has experienced 5 deep downcycles, or, about one per decade. It has been about 15 years since the last deep downcycle. During 4 out of 5 of these downcycles if an investor bought the stock after a -50% decline and held it until it recovered, it would have produced superior returns compared to the S&P 500, and typically produced annualized returns of 20% or more. Those would have been great investments.

It is worth noting, however, that the one time Deere did not produce returns better than the S&P 500 was the 1981 downcycle, and there are certainly some similarities with regard to the Fed's tightening cycle this time around and that of the one in the early 1980s. Farm machinery and construction machinery are very expensive and require financing. Interest rates, of course, are a major factor and will eventually weigh on sales if they stay higher for longer. This wouldn't keep me from buying the stock, but it does help me stay pretty firm when it comes to not buying before a -50% drawdown. It could be a long slow recovery if rates stay higher for longer.

Conclusion

I don't think too many investors have doubts about Deere's overall quality as a business so I'm not going to cover that in this article. The more difficult question is what is a reasonable price to buy the stock as it comes off a very big upcycle. I've found history usually offers some good guideposts to at least get investors in the right ballpark, and to not be surprised when a stock like Deere sells off. Deere stock will certainly recover eventually, but in order to get better than market average returns in a reasonable time-frame of 2-5 years, aiming for that -50% off the high price level of $450, or about $225 per share makes sense. I'll be a buyer if it gets that low.

Of course, there is no guarantee it falls another -38% from here. And some investors might choose to hold onto the stock for fear of not being able to buy it back at a lower price. That's fine as long as they 1) accept that they probably won't have the greatest medium-term returns from here, and 2) are not surprised and panic if the stock price falls a lot more from here and then sell near the bottom. Hopefully, the data and knowledge I've shared here can be useful to readers no matter what they decide to do.

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