Scotts Miracle-Gro: Becoming favorite among agricultural stocks

Sometimes, the market is very blunt in the way it lets investors know what participants are after; other times, it almost takes a doctorate in mass psychology to figure out the secrets of behavioral economics. The former is true today for stocks that operate in the agricultural space; every piece of evidence supports a bull case for them all, with one particular favorite.

So look, it all starts from how the United States FED suddenly gave up its crusade to keep hiking interest rates and how it is now proposing the opposite for 2024, where up to six interest rate cuts could be coming to the markets. If or when this happens, it could trigger a significant turnaround for industries that investors have forgotten.

Of course, that breakout includes a forgotten space like the VanEck Agribusiness ETF NYSEARCA: MOO, especially when you keep in mind that it underperformed the broader S&P 500 by as much as 36.8% in the past twelve months. Within this ETF there is one stock becoming the market's favorite, Scotts Miracle-Gro NYSE: SMG, and for good reason.

Get the bigger picture 

Before you jump to conclusions behind the tailwinds that could push Scotts stock higher, it would be beneficial to understand the bigger trends that are forming everywhere. Whether it helps you make a decision or makes for interesting conversation, it's interesting.

Now that markets have relatively priced in the certainty that the FED will bring them lower rates, and cheaper money as a result, specific industries are beginning to make a comeback. One of these, according to the ISM Services PMI index, is the agriculture industry. 

Some stocks in the space, like Nutrien NYSE: NTR and Mosaic NYSE: MOS, could get some of the benefits of today's constrained crop market, and with an increase in economic activity sponsored by the FED, demand and profits could soon start floating to these names.

However, the crop and food market can be very unpredictable, so here's something more concrete you can focus on. Warren Buffett has just become bullish on construction stocks like Pulte Group NYSE: PHM and D.R. Horton NYSE: DHI, as the U.S. housing market desperately needs new inventory.

How could that be good for Scotts? Well, it is the largest manufacturer and seller of lawn-care plus gardening products in the United States, and in case you have yet to look around much, homes have lawns and yards.

New construction activity will only create a new wave of homebuyers who will need to visit stores like Home Depot NYSE: HD or Lowe's NYSE: LOW to buy Scott's products for their new homes. A story without numbers is a fairytale, so here's how you can back the idea up.

Market's logic 

The company's figures seem to show a gap in the last quarterly financials for Scotts. A discrepancy between net income and free cash flow (operating cash flow minus capital expenditures) will show where this stock's potential truly lies. 

With a free cash flow of $438.2 million, management states the apparent contrast from the reported net loss of $468.4 million. The difference comes mainly from impairment and structuring charges, considered extracurricular charges that skew the actual business' profitability, hence the accurate picture shown in the free cash flow figures.

Markets are beginning to realize this hidden opportunity in the current mispricing of the stock. They are giving investors like yourself a screaming proposal to look at the stock today. Using the forward price-to-earnings ratio can help you gauge what markets are willing to pay today for the next twelve months of company earnings.

The fertilizer industry carries an average forward P/E ratio of 11.0x, placing Scotts at a 53.0% premium to the peer group with its 16.8x multiple. Now, why would markets be willing to overpay for a stock that is posting net losses? Knowing what you know now, you can probably answer that one yourself.

Analysts have also been caught betting on a bright future for this stock, judging by their earnings per share projections in the next twelve months. While the industry is expected to experience an EPS contraction of 7.4% on average, Scotts analysts predict an EPS expansion of 39.2% for the coming year.

Even if it takes the company a little longer to see the benefits of the construction boom, you can rest assured in the fact that management is offering patient shareholders a dividend yield of 4.2% today, competing with ten-year government bonds and indeed beating the inflation rate.