Here’s Why Warren Buffett Bought Deere & Company (DE)

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Fourth-quarter earnings for Deere & Company (NYSE:DE) beat Wall Street’s forecast, but shares tumbled after the agricultural machinery giant slashed its profit outlook on weak conditions in the global farm economy.

Here's Why Warren Buffett Bought Deere & Company (DE)What was Warren Buffett thinking?

As we just learned from quarterly filings, Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) initiated a new position in DE stock. Buffett is of course well aware that crop prices have been tumbling, farm incomes have been shrinking and demand for Deere & Company gear is on the wane.

Valuation is always a key to any investment made by Warren Buffett, so something about DE stock not having gone anywhere in four years must be in the company’s favor. After all, that stagnation has left Deere & Company shares with both trailing and forward price-to-earnings ratios that are significantly lower than the broader market’s.

Another important piece of the Warren Buffett investment puzzle is the quality of management, and that certainly works in Deere & Company’s favor. Ironically, management’s profit warning is a testament to the competent way it has positioned Deere & Company for the downturn.

Deere & Company Manages the Downturn

The global farm economy always ebbs and flows. There’s probably no better or more basic example of the business cycle than agriculture. So it’s neither a surprise nor a disaster that farm incomes are in contraction mode. It happens.

Bumper corn crops in particular are driving down farm income, leaving Deere’s customers less cash to spend on pricey equipment. What’s interesting is the way Deere & Company has prepared itself to weather the cycle.

Deere & Company is forecasting a much better performance in 2015 versus prior downturns in the agricultural market. From 1990 to 1992, Deere & Company’s net income fell about 90%. In the downturn of 1998 to 1999, net income tumbled roughly 77%.

But as for this latest round of retrenchment — from 2013 through 2015 — Deere & Company expects net income to fall less than 50%.

That’s a testament to management and certainly not go unnoticed by Warren Buffett and Berkshire Hathaway.

There’s really nothing Deere & Company can do about the macro picture. Net farm income is forecast to fall 32% year-over-year. At $74 billion, the 2015 tally would be the lowest total since 2009, and a drop of nearly 43 percent from the record high of $129 billion in 2013, says the USDA.

Of course a value investor like Warren Buffett doesn’t particularly like to buy assets when everything is going great. That’s when prices tend to be at the highest. Downturns and recessions are a true value investor’s best friends, because that’s when assets are cheap.

Based on its forecast, Deere & Company hasn’t been this well prepared for a global farm recession in more than 25 years. Presumably that means the company should be spring-loaded for outsized earnings growth once the agricultural cycle heads back into expansion mode.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/02/warren-buffett-deere-company-de/.

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