As Goes Fertilizer, So Goes the Market?

A recession may force consumers to drive less, shop less and buy cheaper items when they do shop, but it won't throw the world into utter starvation.

You wouldn't know it to look at the prices on some agriculture stocks. After each surrendered 9% on October 6, Potash Corp. of Saskatchewan (symbol POT) and Mosaic Company (MOS), two leading fertilizer producers, are now 64% and 77% off their mid-June highs, respectively. Potash, at $86.91, is trading for four times estimated 2009 profits of $21.50 per share, while Mosaic, at $37.16, is going for just three times estimated profits for the fiscal year that ends May 2009. In case you miss the point, stocks with those kinds of price-earnings ratios are cheaper than dirt cheap.

The fertilizer stocks seem to be feeling the worst of a broader selloff in materials stocks. The Vanguard Materials ETF is down 40% from its mid-May peak.

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If the market is truly an accurate discounting machine, then the future of the world looks awfully bleak. At the very least, the market is saying that the earnings estimates for Potash and Mosaic are in La La Land. "These stocks are pricing in a deep worldwide recession," says James Swanson, chief investment strategist of MFS Investment Management.

But some analysts think the selloff looks like the work of frantic hedge funds facing investor redemptions or liquidation. "Hedge funds are a big portion of the market now, and everyone's trying to raise cash," says Greenwich Consultants analyst Michael Judd. "Now hedge funds are being forced to sell what had been their winners," he says.

Indeed, the stocks were high-fliers through the first half of the year. In the year leading up to their mid-June peaks, shares of Potash and Mosaic gained, respectively, 210% and 315%. Driving the companies' seemingly limitless profit growth has been growing wealth in emerging markets. That has led to growing demand for better and more-nutritious foods and that has caused potash prices to soar 300% over the past two years.

Standard & Poor's analyst Richard O'Reilly says that, so far, the big picture for these companies hasn't changed: More people than ever need to be fed, and there's less arable space to raise all those crops. That means farmers need fertilizer to up production. "We're not going to be eating less next year and neither are the Chinese or the Indians," O'Reilly says.

Bob Froehlich, chief strategist for DWS Investments, agrees that the stock prices seem disconnected from reality: "With these prices, investors are saying that fundamentals don't matter anymore."

Granted, it's plausible that profit estimates have become a bit overambitious. On October 1, Mosaic reported profits per share of $2.65 for the quarter that ended August 31 -- a 284% profit increase over that same quarter in 2007. Yet investors sold the stock off 40% that day because profits missed analyst expectations by 29 cents per share.

It's also plausible that these dirt-cheap shares could still get cheaper. After all, as the credit crunch continues to play out, Wall Street is working through a giant de-leveraging process, and it's unclear how much more selling hedge funds and other investors may need to do. Plus, "emotional investors often don't know when to stop," Swanson says.

But Potash and Mosaic could prove to be rewarding long-term investments if you're willing to sit tight should sellers continue to pound the shares. "These are the times when you actually make money," says Froehlich. "This is like another chance at joining the commodity boom."