Know Your Weighted Average
Nov 24, 2010
Most people discovered back in middle school that numbers make them emotional. If you ever received a grade of 60 percent on a test, chances are you were not happy. On the other hand, how did you feel after scoring a 100?
What really mattered, though, was your report card. It defined how well you fared overall. In marketing, we call this the weighted average price. It is the grade that matters.
Your weighted average price is the value of priced bushels, un-priced bushels assigned the current market value, and hedge positions. This figure has the power to help you make important marketing decisions while remaining unemotional. To illustrate its influence, allow me to provide a true example.
A producer called, wondering what to do with priced corn bushels for the 2011 crop year. He felt he had sold the bushels “too soon” at the $4.30 futures price. The current price on futures at the time was $5.20 for the 2011 crop.
As it turned out, he had sold 20,000 of his 200,000 bushels at this level. So, only 10 percent of his estimated production was priced. Yet, with his gut telling him he was behind and in need of making up ground, he asked whether he should buy back those bushels.
Rather than focus on this one sale, we looked at his weighted average price. Here’s how we came up with his “report card” for that moment in time:
- Multiplied 10 percent cash sold by the $4.30 futures price (equals 0.43)
- Multiplied 90 percent of the un-priced bushels by the $5.20 futures price (equals $4.68)
- Added 0.43 and $4.68 (equals $5.11)
- Summary: The weighted average price of his entire crop was $5.11 vs. the $5.20 futures price— hardly a difference when talking 10 percent of the crop.
After looking at his sale through the lens of his weighted average price, this producer was able to rationally decide that it wasn’t necessary to buy back any of the 10 percent sold bushels. Going back to my middle school analogy, that 10 percent was just one grade along the way toward his final report for the year.
It’s necessary to note that given this producer’s risk tolerance, it was important that he make the 10 percent sale at $4.30. It was part of an overall strategy to incrementally capture opportunity and manage risk. Had the market gone down instead of trending upward, that sale would have been very important for managing risk. Incremental sales are part of an overall strategy to build the best possible weighted average price, taking into consideration your farm’s financial position and risk tolerance.
You can use the concept of weighted average price to consider future price scenarios and pre-plan your marketing decisions. Imagine the market going up a little or up a lot, or down a little or down a lot. Then, keeping your risk tolerance in mind, consider where you would have to make sales in order to maximize profits and minimize risk.
If you do not already pre-plan and assess your marketing using your weighted average price, I encourage you to do so. It helps eliminate second-guessing of decisions you execute along the way and can prevent you from making decisions in isolation—that is, decisions that are neither interrelated nor based upon preset goals.
All of your marketing decisions should be related. They ought to be made like they’re in the context of a spider web, in which an action at any point in the web creates a ripple that affects all parts of the web.
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at email@example.com.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.