Like beauty, profit is in the eye of the beholder. That's especially true in the quick-turn, gain-driven margins of the stocker business.

Some examine return on investment after enterprise analysis so meticulously that Ebenezer J. Scrooge seems a careless spendthrift in comparison. Others ignore fixed or opportunity costs, or figure their labor is free. Still others take a more sanguine approach.

“Some years, you make money. Some years, you lose money. When you die, you just hope you're even.”

When Ted McCollum was growing up, that's how a veteran stocker-operator on the neighboring ranch answered his dad, a lifelong cow-calf man wondering how economics and profit worked in the stocker business. Since then, as a Texas A&M University Extension beef specialist, McCollum has seen a myriad of approaches used to assess stocker profit.

“Some producers won't charge themselves for pasture they own. If they raise hay, they may not attach an appropriate market value to it, or may not account for labor,” McCollum says. “Some assume the profits will cover those expenses.”

Likewise, Walt Prevatt, an Auburn University Extension economist, explains some stocker-operators ignore depreciation. Even with net farm income — cash income minus depreciation and sometimes adjusted for inventory — Prevatt says, “We still haven't paid ourselves anything for our labor and management or the capital we own.”

That's why Prevatt is a fan of using net returns to gauge profit. It accounts for cash expenses, depreciation, labor and management, along with the opportunity cost of the capital invested.

“In order to maintain a constant standard of living, total net returns must increase to keep up with inflation,” Prevatt says.

Short of that, McCollum explains that including a market cost for owned pasture in the budget, and a cost for labor, will at least account for returns to land and labor at breakeven levels.

“If I'm making payments on land or leasing it, land cost is a true cash cost I must cover. So I'd better include profit in my budget that goes beyond breakeven,” he says.

Assessing the paths to profit

With that in mind, both Prevatt and McCollum suggest stocker-operators evaluate a set of calves' potential profit by budgeting appropriately for their profit goals. In all cases, however, the budgeting process should begin with risk management, McCollum says.

“When producers call me, either thinking about buying calves to start a stocker enterprise, or wondering about retaining ownership through the stocker phase, I start by asking lots of questions about their variable costs,” McCollum says. “Do you know how much it will cost you to straighten out a set of calves? Do you have the experience and expertise? What's the stocking rate and anticipated gain? Then we start attaching numbers to all those kinds of things.”

Prevatt also believes knowing and managing costs is the most basic risk management tool available to the stocker operator.

“When you budget for cost, weight gain, death loss and other variables, you're accounting for any management variables that could make your projections inappropriate. So, the first risk-management tool is accurately identifying and accounting for cost in budgeting projections,” McCollum emphasizes.

With cost knowledge as the foundation, there are a number of ways to get at potential profit.

In Alabama, for instance, Prevatt encourages producers to begin with a complete enterprise analysis. Then use those numbers to calculate simple breakevens, figure the maximum price you can pay for cattle relative to a specific profit objective, or analyze the possibility of achieving a specific profit objective based on a given pricing opportunity.

The breakevens most folks are familiar with are fairly straightforward. Figure out the projected total costs of buying cattle, projected total production costs for weight gain, and the total saleable weight (initial weight, weight gain and an adjustment for death loss) and do the math. This will determine how much you've got to sell them for to stay even.

“Basically, breakevens are a quick estimate. They offer you a quick indicator to determine the possibilities. It's more focused on the marketing of the animal,” Prevatt says.

Conversely, he explains, “With the maximum price calculation, we've got an idea of cost of gain and what the futures are telling us in terms of the price we could expect in the next six to eight months. Then we can determine the maximum price we can pay and still achieve the desired return,” (Table 1).

By way of comparison, setting a price objective defines a marketing price point at which the profit goal can be achieved. With the trigger price defined, you can fully explore the possibilities of managing price risk before buying the calves.

“I like to sum my cost of production and desired profit to determine my feeder cattle price objective or trigger price,” Prevatt says (Table 2). “Next, I check the futures potential daily by adding the futures contract price and my expected basis. This gives me my expected cash price. When the expected cash price exceeds my trigger price, I pull the trigger and protect my cost of production and profit on this set of cattle.

“If the cattle market shows continued upward movement, I may wait to pull the trigger. But, if there is uncertainty in the market I can take my trigger price and achieve my price objective,” he adds.

Spreadsheets for the different calculations Prevatt describes are available at www.ag.auburn.edu/agec/pubs/budgets.

Projecting prices also requires an eye on the rearview mirror. As seasoned stocker-operators know, feeder prices typically are lowest in fall and highest in late winter/early spring. But, the charts haven't indicated that the past few years.

“After 9-11, prices sank in the last quarter of 2001 and first quarter of 2002. Then the Russian ban on U.S. poultry pressured prices in 2002,” Prevatt says. “In the last quarter of 2003 and first quarter 2004, it was BSE. So the most recent seasonal 10-year, first-quarter price trend (1995-2004) for those three years is below the average. Typically, prices for January-March would be above the historic price line, but they're not due to declining prices. You have to know what typical is.”

Similarly, McCollum says it's not enough to know that March-May futures contracts often offer risk-management potential for winter stocker programs. You must also understand that seasonal highs for those contracts typically come in January.

“People need to keep up with what's happening in the markets today, and how it may impact cattle prices three months down the road,” McCollum says.

What's a reasonable profit?

Like assessing profit, defining a suitable profit level is as diverse as the folks running cattle.

“I've heard some stockers say, ‘If I can't make $50/head free and clear, it's not worth my time.’ Sometimes that isn't possible,” McCollum says.

Prevatt looks at historic profit/loss frequency (Table 3) to gauge the rationality of profit desires. He says running stockers in Alabama from fall to spring over the past 26 years would have incurred a loss 27% of the time.

“That's where you start. Is that acceptable? Then look at historic profit levels (Table 4). Is that enough?” he asks.

Using those tables, if a producer set $50 for a profit objective, it would have been achieved 54% of the time. So, about half the time, that much profit would be a realistic profit goal in Alabama.

“If I figure that profit level into my breakeven and can't achieve it, I can choose not to participate. Or I can choose to participate and try to average that profit objective over time,” Prevatt says.

McCollum suggests profit levels also be considered in relation to alternative investments. As an example, suppose the bank requires $100/head equity to finance your stocker venture. How much return could you make investing that $100 in something else?

“If I can clear $30/head on stockers I've purchased with $100 equity in September, to run on wheat pasture until April, that's a 30% return in eight months,” McCollum says.

“The value of gain over the long term is about 50¢/lb. and the cost of gain is about 40¢/lb. for winter programs in Alabama. On 400 lbs. of gain, that's about a $40/head return, or more like $30-$35/head after death loss. Is that enough to attract me to the business?” Prevatt asks.

For added perspective, average profit for summer stocker programs has been about $20/head for the past 25 years, according to Cattle-Fax, not counting the last two atypical and astronomical profit years.

McCollum also points out that desired profit levels should be considered alongside cost structure. If you're including labor and land cost in the budget, for instance, he says it would be reasonable to assume the profit objective would be lower than if those costs aren't included.

Rational usually wins the race

Likewise, reasonable cost and performance projections are the keys to estimating profit potential.

“There are stockers on both sides of that equation, some that are too liberal and some that are too conservative,” McCollum says.

Thus, a gambler might figure he can trim his historic 3% death loss by 1% on the next set of calves. Meanwhile, an overly-cautious player might bump death loss to 4%, just in case. Neither is a rational assumption based on the records.

The same goes for figuring stocking rates and cost of gain.

“Stocking rate will influence whether cattle hit your projected target weight and whether the cost to achieve that weight is at or below the projection,” McCollum says.

Of course, this also holds true when assessing individual management practices aimed at increasing gain, be it irrigating and fertilizing pastures, or implants and feeding supplement.

“Anytime I'm going to do something to put more weight on cattle or run more of them — increase pounds of production per acre — I have to properly define the margin,” McCollum says.

Supplementation is a prime example. Suppose the cattle under consideration are projected to bring $110/cwt. when sold at 600 lbs. ($660/head). Assume that with supplement, those same cattle could hit 650 lbs. in the same period of time. Assuming an $8/cwt. rollback in price, these heavier calves would bring $106/cwt. ($689/head). In gross terms, that's a $29/head difference. The value of the additional gain is $58/cwt.

“Some guys err by calculating the cost of supplying supplement, which is fairly straightforward, but then assume the added weight due to supplement is worth the market price,” McCollum says.

Prevatt also encounters producers who equate the value of gain to the selling price. He emphasizes, “The value of gain is the gross margin (sale value/head minus purchase value/head) divided by pounds of gain. It's not pounds of gain multiplied by selling price.”

As far as that goes, another common error on the ledger's cost side is failing to include the costs of marketing and managing price risk. Whether it's buying puts, paying sales commission and freight, or figuring shrink associated with marketing, all cut into profit.

“All you can really do on the market side is take the opportunities presented to you,” McCollum says. “We need to worry about the things we have some control over, not what we can't control.”

Of course, the most comprehensive calculations in the world can pale compared to the innate talent of some stocker-operators who seemingly have mastered the art of seeing and retrieving profit from cattle in ways others can't.

“It takes a trained eye to see a No.-2 quality calf that can become a No. 1, or to buy a 400-lb. calf with a 500-lb. frame. It also takes experience and above-average management to help those calves reach their potential,” Prevatt says.

Even then, however, budgets and projections help focus the eye on reality.