The Basics of Agriculture Investing

Worldwide Invest Better Day 9/25/2012
Worldwide Invest Better Day 9/25/2012

Today, September 25, the Fool is promoting Worldwide Invest Better Day. The idea behind WWIB Day is to "educate, inspire, and motivate" investors of all experience levels to, well, invest better. Some of us Fools are pitching in to give readers an overview of individual companies and sectors to give investors a crash course in different areas of the investing world. With that in mind, let's take a look at the basics of agriculture investing.

The case for investing
The United Nations estimates that food production will need to double by 2050 to keep up with the rising demands of a growing population. Farmers will be fighting an uphill battle to meet that goal, as climate change makes it increasingly difficult to avoid years with a bad harvest. Despite the much-publicized drought this summer, farmers in August were still expecting the eighth-largest harvest ever, which highlights how much we've come to depend on a bountiful food supply, and the investment opportunities that it presents.

Things that grow
Agriculture investing can be broken down into two basic groups: things that grow, and things that help things grow. In the former category, you have crops like corn and cotton, as well as livestock. In the latter category, you have things like fertilizer and machinery.

The "things that grow" category is not easy to invest in. Crops in particular are dicey. There are very few publicly traded companies that focus on crop production. The ones that do exist are highly specialized, like Diamond Foods, which mostly focuses on nuts.

Livestock companies, on the other hand, are a little more common. Unfortunately, they come with their own set of problems. Livestock companies are highly sensitive to feed prices -- mostly corn and soy -- which can shift direction at lightning speed depending on weather and other conditions. When feed prices get too high, these companies aren't able to raise prices either, because the price of meat is largely set by supply and demand. While the effectiveness of a company's business and management is certainly a factor, these companies can at times become simple proxies for commodity prices.

On the subject of commodity prices, it is possible to invest directly in certain specific crops and livestock animals, or a diversified basket of them, through exchange-traded funds and exchange-traded notes. You won't get a lot of long-term growth this way, and you're basically betting against human innovation, but it's often touted as an inflation hedge, and can be used as a smart hedge if you do choose to invest in a company sensitive to changes in a certain commodity. Pilgrim's Pride (NYSE: PPC) , for example, is sensitive to corn prices. Buying shares of the Teucrium Corn Fund would have protected a Pilgrim's investor from a lot of his or her losses over the recent summer.

Things that help things grow
Chemicals and machinery are considerably easier to invest in, and less volatile. With chemicals you have fertilizers, pesticides, crop nutrients, and specialized seeds. The companies in this category are still sensitive to crop prices, but not as much. They benefit from high crop prices, because farmers are more likely to plant more when prices are high, and use any tools available to them to ensure a large harvest.

Chemicals companies also benefit from long-term trends, however. Many parts of the developing world don't use fertilizer, so there's a lot of room to grow for big fertilizer companies like PotashCorp (NYSE: POT) , which can help developing countries boost their crop yields. Similarly, DuPont (NYSE: DD) has a line of drought-resistant seeds that can help farmers produce more consistent harvests and use less water.

As farmers plant more crops and reap larger harvests, the need for more efficient equipment will increase as well. Again, the developing world represents a large opportunity, as farmers in developing countries generally rely more on traditional irrigation, planting, and harvesting methods. While Deere (NYSE: DE) is the biggest player in the farm equipment world, AGCO (NYSE: AGCO) has a greater focus on emerging markets and is likely to benefit more from long-term trends.

The Foolish bottom line
There's a lot more to learn about how these companies interact and the factors behind their success or failure, but this should get you started as you delve deeper and find worthy investments. Once you reach that point, the best places for further research are the SEC's database of company reports, as well as specialized databases like the Statistics Division of the Food and Agriculture Organization.

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Originally published