Sunday, November 23, 2008

Archer Daniels Midland

We discussed earlier that airlines are risky businesses due in large part to their cyclicality. When times are bad, it becomes very difficult for cyclical companies to make payments, which can easily lead to bankruptcy.

At the other end of the "cyclicality" spectrum is Archer Daniels Midland (ADM), which procures, transports, stores, processes, and distributes agricultural products including corn, wheat, cocoa, soybeans, flour, ethanol and biodiesels. Whether in a recession or not, the demand for many of these staple items doesn't change by much if at all.

ADM has a P/B just over 1.2, along with a P/E of 7, suggesting there could be some value here. However, it's important to note that many of the items sold by ADM are commodity products. As we discussed here, value investors are not big fans of companies heavily reliant on commodities as future revenues and earnings are very difficult to predict.

In the case of ADM, recent spikes in food prices have made recent results higher than normal. As such, investors must be cognizant of this fact when evaluating metrics like P/E ratios which are based on the most recent numbers. As discussed here, value investors tend to prefer using earnings averages rather than the most recent earnings. A failure to do so would make you think ADM is far cheaper than it actually is...

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