Dangerous Valuations in Farm Products

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The world needs its farm goods, and the market is well aware of this. The problem with something that everyone knows they need is that the price can become insane. The following are some examples of companies that at first glance look like stocks in which you might want to wait for a dip before buying. 

The burden of a good reputation

Archer Daniels Midland (NYSE: ADM) has some good things going for it. As a diversified provider of agricultural services, such as trading, storage and transportation, Archer Daniels has a strong level of vertical integration. Rated by Fortune as the most admired food production company from 2009 to 2011, the company also has a strong reputation. With a 2.1% dividend yield, Archer Daniels also has a solid line on being an income investment.

Unfortunately, there are some problems here. For one, despite $91.3 billion in trailing annual sales, the company is only rocking a 1.4% profit margin. This could indicate that if a problem occurs, Archer Daniels may have difficulty keeping its operation running smoothly. Also, trading around 19 times its earnings means that the company's price is a bit steeper than much of the S&P 500 -- not exactly a bargain. While you could find good value in Archer Daniels, I would recommend buying in on a dip or waiting until the next quarter to see if the profits pick up.

Skipping a step

Bunge (NYSE: BG) operates in 40 countries and does a lot of work in international soybean export and grain trading. The sheer volume of international exposure Bunge carries gives it a great deal of currency resistance -- using currencies from all over can help keep earnings stable. The company is also a decent income play, with a 1.6% dividend. It has also carried a clean environmental record since 2006, having mended its factories to bring them into compliance.

However, there are issues keeping Bunge from being a great buy. For one thing, the company is barely earning a profit, holding only 0.2% profit margins. While Bunge is trading almost exactly at its book value, it is also trading at around 96 times its earnings. This raises serious red flags about the company's prospects of gaining value. For a company with a $10 billion market cap, this is a pricey situation.

Beyond this, there is a vital gap in the integration process that Bunge is missing, and that's the actual production of basic components. While the company works in transportation, fertilizer and processing, growth is the most important aspect of produce. This opens Bunge up to a lot of volatility based on commodity prices, which can make the stock even riskier.

Held up by a string

Cosan (NYSE: CZZ) has great potential because of its diverse use of sugar cane. With 600,000 hectares of production space and a rich environment in which to produce its bioethanol, Cosan has plenty of opportunity to ply its trade with amazing results. Operating in Brazil, which prohibits the sale of gasoline automobiles, is also a boon for the company. This is not even counting the fact that having much of its operation take place in Latin America provides plenty of growth potential due to the heated economies in the region.

However, there are issues to be found here. For one thing, Cosan is a bit pricey at around 24 times its earnings. The company is also one of the higher priced in its industry on a book value basis, trading at a book multiple of 1.5. But beyond the valuations, there is ample danger because Cosan is only pulling in 1.4% profit margins. This presents high risk that something could go wrong, the company could slip into unprofitability and the share price could plummet. I would recommend waiting on Cosan until the profit margins rise before moving on this opportunity.

The Foolish bottom line

The farm-products sector is critical for society, but it's not necessarily critical for your portfolio. As the saying goes, sometimes discretion is the better part of valor. The stock of even the best company isn't a great investment unless you can buy it for a good price.

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Chris Hodge has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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