If power is borne in simplicity, then the notion of dollar cost averaging (DCA) the annual investment for replacement heifers is downright nuclear in its potential.
“The secret of economics is always figuring out what everyone else is doing, then doing just the opposite,” says John Lawrence, director of the Iowa Beef Center at Iowa State University. That means the typical cyclical approach to expanding and reducing the cowherd — keeping more heifers when prices are increasing and selling more when prices decline — runs counter to buy-low, sell-high profit logic.
Consequently, Lawrence explains maintaining the same dollar investment in heifers purchased or retained each year can return more jingle over time. That's compared to either maintaining constant cow numbers by replacing the same number of heifers or by maintaining the same annual cash flow by selling more or fewer heifers.
Dollar Cost Averaging
Lawrence explains it this way. If a producer focuses on a constant annual heifer investment — say the percentage of the herd you plan to replace each year multiplied by the 10-year average price of those heifers — in effect, the producer will be doing just the opposite of the cycle. He's selling more heifers when they are worth more and retaining more of them when they are worth less.
Over time, that means a producer will sell more cattle and at higher average prices relative to the market. The spread in annual returns, however, will be more significant than focusing on a constant herd size or cash flow.
Lawrence studied the impact of these three strategies over a 30-year time frame (Table 1). Average total revenue, return over total economic cost and return over cash cost were all highest with DCA and lowest by employing a strategy of constant cash flow. What's more, accumulated cash associated with DCA was 34% higher than maintaining herd numbers at a constant rate, and 56% higher than focusing on cash flow.
“If anything surprised me (in this economic model) it was that using cash flow as a strategy turned out to be such a train wreck; you are essentially eating your seed each year,” he says.
Specifically, when cattle are worth less, producers are selling more of the factory to meet pre-determined cash flow. That means they have less cash flow to expand the factory when doing so is more expensive.
Moreover, the fact that the DCA strategy works in Lawrence's economic model, using real world numbers, speaks to the fact that few producers embrace the principle. If everyone was doing it — buying and selling opposite the cycle — obviously, it couldn't work.
Of course, cash flow is the very reason plenty of folks haven't considered it, let alone employed such a strategy. Lawrence points out a producer must have a strong financial position to weather the wide annual return swings that come with DCA. Or, he says, a producer needs diverse enough enterprises to buffer the impact of the swings.
Although Lawrence's model assumes retained heifers rather than purchased ones, he says the impact of the strategies could be more significant with purchased heifers that at times can be purchased for less than the cost of production.
Moreover, along with cash flow, Lawrence says land use must be an imperative consideration. To DCA, producers must have the land flexibility to retain more heifers some years or contract the herd during others. Stocker cattle, crop ground and lease acres are all means to flexibility. The model above assumed a flexible land base rather than fixed.
Consequently, adding and subtracting enterprises from year to year in order to maximize use of the land impacts the returns described above. When Lawrence incorporated a stocker enterprise in his model to balance land utilization, he explains: “Dollar cost averaging generated returns over cash costs 22 percent higher than maintaining a steady herd size, compared to 33 percent in the analysis that assumes complete land flexibility.” A similar but diluted advantage also occurs in accumulated herd net worth.
There's nothing exact about this method. Rather than an absolute prescription, Lawrence says, “This is an alternative strategy than can serve as a guiding principle on how to manage the herd.”
For more details about Lawrence's DCA model compared to maintaining the herd at a constant size, cash flow at a constant level or investing based off a 10-year rolling average, check out his complete report at www.iowabeefcenter.org under “cow/calf management,” then “economics.”
Table 1. Annual revenue and return (1970-1999)
SS = Maintaining herd at a steady size from year to year
CF = Maintaining cash flow at a constant rate from year to year
DCA = Dollar cost averaging the same investment in replacements each year
RAV = Retaining the 10-year average value of replacements each year
|Total annual revenue ($)|
|Annual return over total economic cost ($)|
|Annual return over cash cost ($)|
|Source: Iowa Beef Center/Iowa State University|