Why John Deere Shares Jumped ... and Why There's More to Come

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis. 

What: Shares of Deere climbed 4% in trade today as the farm-equipment maker announced plans to reward its shareholders with an additional share buyback program worth $8 billion.

So what: The $8 billion buyback will be a continuation to Deere's $5 billion share repurchase program running since May 2008. As of Oct. 31, $1 billion of that remained unexecuted. So in effect, Deere will buy back $9 billion worth of shares over the next few years. The company has already repurchased shares worth $11 billion since 2004.

Now what: Before trying to make sense of Deere's move, you need to know something about buybacks. Companies often buy back shares when their profits are expected to grow at slower rates, or even decline over the next few years, in order to deploy available cash and support earnings per share. In such cases, shareholders don't really benefit because the growth in EPS is backed by a decrease in outstanding share count (the denominator when calculating EPS) instead of an increase in profits (the numerator). Simply put, the wealth of existing shareholders actually dips in such a scenario.

Fortunately, that's not the case with Deere. Analysts estimate Deere's earnings to grow 8% over the next five years. That should keep the company's cash boxes ringing. Deere already has a strong balance sheet, with $900 million in free cash flow and more than $5 billion in cash and equivalents for the financial year ended Oct. 31. Deere has increased dividends by 82% since 2010, and has returned nearly 60% of its operating cash to shareholders in the form of dividends and buybacks since 2004.

Investors should know that Deere has prioritized its cash outlay well, with share repurchases ranking as the last option after the company has taken care of its debt level and rating, funding its expansion plans, and growing its dividends. So the latest buyback announcement indicates management's confidence in the company's growth prospects in coming years, which is great news for investors. Solid brand image, great global presence, and dominance in the global farm-equipment market should continue to boost Deere's profits. And when it wants to share those gains with its shareholders, the stock certainly calls for attention.

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The article Why John Deere Shares Jumped ... and Why There's More to Come originally appeared on Fool.com.

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