Deere (DE -0.87%) stock has been under pressure as the peak of its earnings boom seems to be over. However, the agriculture, construction, and forestry original equipment manufacturer is still delivering impeccable results that have far exceeded pre-pandemic levels.
Here's why Deere is an excellent dividend stock to buy around its two-year low, even if earnings growth clocks lower in the future.
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Deere is coming off a historic boom
The best way to approach a cyclical company like Deere is to avoid getting caught up in the quarterly results and focus on the big picture. The best cyclical companies can capitalize on expansion periods and minimize the effect of a slowdown. So instead of booms and busts in earnings, the goal would be to get as close to a "staircase" pattern as possible -- where each expansion period is better than the last, and there aren't significant declines in earnings during slowdowns.
Looking at Deere's diluted earnings per share (EPS) over the last 20 years, we can see the multiyear periods of growth and the slowdowns. Notice how the slowdowns often revert to the prior expansion period.
DE EPS Diluted (TTM) data by YCharts.
Looking at the chart, you can also get a sense of just how extraordinary the recent expansion period has been. Earnings have more than tripled from pre-pandemic levels, which is an unusually high amount of growth in a relatively short period.
A slowdown was inevitable. When it reported its full-year fiscal 2023 results in November, Deere initially guided for fiscal 2024 net income of $7.75 billion to $8.25 billion -- which would be around a 20% decline compared to a record $10.166 billion in fiscal 2023.
But in its second-quarter 2024 earnings release, Deere updated its guidance for full-year fiscal 2024 net income of $7 billion, which is more like a 30% decline in just one year. Normally, that would be a fairly significant slowdown, but again, context is key. If it hits its target, Deere will be back to fiscal 2022 earnings levels -- which is still fantastic because it is more than double what it was earning pre-pandemic in fiscal 2019. And it's not like fiscal 2019 was a terrible year for Deere either. In fact, it was close to a record high in terms of profits.
Deere is set to have a substantial decline in earnings, but only relative to outsized gains in recent years.
Putting Deere's valuation into context
Without considering more buybacks in fiscal 2024, Deere would have a 13.9 price-to-earnings (P/E) ratio based on its market cap of $97.2 billion and $7 billion in fiscal 2024 net income. The P/E ratio isn't a perfect measure of a cyclical company because of the ebbs and flows in earnings. But in general, Deere should have discounted valuation relative to its historical average during expansion periods because of outsized earnings and a higher-than-historical P/E ratio during slowdowns due to lower earnings.
Looking at Deere stock's median P/E at various intervals over the last 10 years, its current valuation would still be below historical levels -- making Deere underpriced even though its earnings would be down 30% in a year.
DE PE Ratio data by YCharts.
To get to that 17-or-so mid-cycle P/E ratio, Deere would have to make around $5.7 billion in net income -- meaning earnings would have to fall by nearly 20% in fiscal 2025 on top of the 30% slide in fiscal 2024.
The key takeaway is that Deere's earnings would have to fall much more for the stock to be overpriced. And if Deere stops the bleeding after this year and returns to growth, it will look even cheaper.
Despite its earnings fluctuations, Deere has kept its dividend steady or raised it every year since 1988. The current quarterly dividend is $1.47 per share, more than double what Deere paid six years ago. Deere also buys back a lot of its stock, reducing its share count and allowing EPS to grow faster than net income. Diluted EPS is up 285% over the last decade compared to a 200% increase in net income, thanks to a 20% reduction in the share count.
Deere is too good of a company to be this inexpensive
Deere is delivering excellent results from its operations while rewarding shareholders through buybacks and dividends. Deere's valuation is too cheap for its level of quality.
Investors are getting a great price for Deere stock even if its earnings continue to fall next fiscal year -- making Deere stand out as an excellent dividend stock to buy now.
