How will your kids judge you on your management of today’s once in a lifetime bonanza? Ag banker and strategist Michael Swanson, Wells Fargo senior agricultural economist, worries that farmers are buying land at any price, at a big cost to future generations. He poses the questions below to farmers, as the stewards of multi-generation businesses. “These questions are about preserving future options, after the good times have gone,” he says. “Just as previous generations shepherded your business, ask yourself some questions to temper today’s sizzling once-in-a-lifetime environment.”
Below are Swanson’s exercises, to guide you while times are good and you can fine-tune your course.
What’s the most cost-effective way to produce another 20-40% more bushels? There are two ways: Buy more land, or increase your productivity per acre. In most cases, it makes more financial sense to invest in irrigation, tiling, conservation tactics, soil health improvements or other productivity tools that boost your productivity per-unit, given relative change in opportunities.
Revisit projects that made no financial sense when corn was at $2.50 and interest rates were higher.
Do I really want to buy a $14,000/acre of land to produce more bushels? I can probably buy future production cheaper than that from my current acres.
Can I take $1,000/acre to install irrigation and increase yields by 20-30% to grow my returns?
You could easily see 8-14% rates of return on irrigation and other yield-boosting projects, even with $5 corn and $12 soybeans.
Recognize the false signals in today’s marketplace. Ultra low interest rates, designed to stimulate housing demand, have distorted the value of all assets. That backfires by falsely causing farmers to underestimate the future cost of financing.
Yet high land prices actually motivate sellers to withhold land from the marketplace in hopes of better prices next year. So we have less supply, spiraling land prices higher yet.
This windfall, with land prices rising much faster than any other asset class, makes most land prices too high to make sense as an investment. Do you really want to chase those 120 acres next door that is finally for sale, with no limit on what you will pay?
What is the internal rate of return on any potential investment?
I can easily see a 10% internal rate of return on improving your productivity per acre. That is very attractive to any business and certainly a better price/earnings ratio than buying another 40 acres.
The 1980s taught us that you can always overpay for capacity. If you have a stock that pays you a $5 dividend annually, that’s not good if the stock cost you $500 (that would only be a 1% ROI). But if you paid $1 for a stock and it paid a 20¢ dividend, that’s a great investment. Run your own numbers. But in most cases the best investment is not buying more ground in this current market.
Scrutinize any potential investment’s price/earningsratio. A wise investment might be a retirement fund or an investment outside of farming. A P/E ratio is a common measure of value. Wells Fargo, for example, has a P/E ratio of about 10. Land’s current average P/E of 30 would need an incredible growth story to make sense. But there typically is limited growth potential there; it’s already been captured when you paid what you did for it in today’s overheated environment.
Discipline. Success is a matter of being smart, and at the same time, it’s also a question of discipline. Sometimes you’re successful from doing deals; other times it’s from not doing deals.
Define 15-20% of your time for strategic planning. Only you can shape the best future returns for your family business.
And since smart people don’t give away their talents and experience for free, consider purchasing quality management advice as an input. Ask yourself what is the marginal value of buying tax consulting or financial strategic financial consulting? You probably need it, although you will not see a straight-line benefit as you do buying additional fertilizer for an underperforming field. Good advice begins by removing you from the “group think” coffee shop environment and applying proven management principles to your operation.
Be careful what you wish for. Today’s high crop prices stimulate competitors’ productions which will come back to haunt us. Markets always get ahead of themselves. The ethanol, fertilizer, hog and broiler industries are suffering or have suffered from added capacity motivated by high prices. Once added capacity is in place, there is a death match as others compete on operating cost. Eventually they compete on marginal cost, go bankrupt and then finally compete on more normal basis.
Don’t underestimate global response to high prices. These are patterns that we can anticipate.
The growth rate of grain production from 1985 to 2007 was pretty weak because prices were low; there was no incentive for more capacity to come online. These questions and suggestions may feel like Mom telling you to eat your spinach. The bottom line, beyond “success,” is passing on a sound business, just as previous generations did for you.