In the world of investing, one of the toughest decisions is knowing when to sell a successful long-term investment. Nobody likes parting ways with a profitable company, but sometimes the fundamentals change or the investment becomes overvalued. This appears to be the case for Deere & Company (NYSE: DE), one of the most renowned and top-performing stocks in the market.
Over the past five years, Deere has delivered remarkable total returns of 201.63%, outperforming the S&P 500 (SPY) which offered a total return of 70.68% during the same period.
Deere’s success can be attributed to several factors. The Russia-Ukraine conflict led to a surge in agriculture and grain prices, low interest rates reduced buying costs for farmers, and pent-up demand in 2022 caused by supply chain shortages resulted in increased tractor sales. However, it’s crucial to recognize that these factors may not sustain Deere’s growth in the long run.
Upon my analysis, I initially rated Deere as a sell in May of this year. Since then, the stock has declined by 7.55%, while the S&P 500 has grown by 4.13%. Given the changing landscape, I am now revising my rating to strong sell for Deere. Here’s why:
Peaking Earnings and Margins
Deere’s third-quarter earnings report may seem strong on the surface, with earnings per share exceeding analyst expectations and revenues beating estimates as well. Nonetheless, the company’s guidance suggests that the agricultural business earnings cycle is likely peaking. Management has slightly raised full-year guidance for 2023 but given the conservative growth estimates of 1-2% per year, Deere’s earnings and margins face challenges moving forward.
Data by YCharts
Unsustainable Price Increases
While Deere has successfully raised prices in recent years, the pace of these increases is unlikely to be sustainable. The agricultural industry is experiencing rising inventories of used agricultural equipment, indicating that supply is surpassing demand. Deere’s reliance on price increases for revenue growth rather than increasing sales volume raises concerns about the company’s future profitability.
An excerpt from Deere’s earnings report
Downward Revisions and Economic Slowdown
Deere also faces headwinds due to declining support for Ukraine and signs of an economic slowdown globally. Fitch recently revised down its global growth estimates to 1.4% and the US growth estimates to a mere 0.2%. Consumer savings from the pandemic are dwindling, wage growth remains flat, and consumer confidence levels are decreasing.
A graphic of Fitch’s recently revised growth estimates
Overvaluation and Cyclical Risks
Considering Deere’s current valuation, the stock appears significantly overpriced. Deere’s forward EBITDA and sales multiples are higher than the industry average. Furthermore, analysts forecast negative earnings per share growth over the next two years, and the company operates in a cyclical industry with headline risks.
While Deere is undoubtedly a well-managed and iconic company, it’s essential for investors to assess the current market conditions and seek better value elsewhere.
Investors must carefully evaluate their investments and adapt when necessary. In the case of Deere, the fundamentals indicate that the sell-off may worsen, making it wise to reconsider the investment in this profitable yet uncertain industry.
