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Should You Buy the Dow — Caterpillar

Caterpillar should be able to withstand even a double-dip


Should You Buy the DowToday we’ll look at Caterpillar (NYSE:CAT), the 86-year-old machinery company. Actually, Caterpillar offers a lot more than construction equipment, and it’s even in the financial business.

The Machinery Segment offers construction, mining and forestry machinery. It also manufactures diesel-electric locomotives, and it manufactures and services rail-related products and logistics services for other companies. The Engines Segment provides diesel, heavy fuel and natural gas reciprocating engines for Caterpillar machinery, electric power generation systems, marine, petroleum, construction, industrial, agricultural and other applications. It offers industrial turbines and turbine-related services for oil and gas, and power generation applications.

The Financial Products Segment provides retail and wholesale financing alternatives for Caterpillar machinery and engines, solar gas turbines and other equipment and marine vessels, as well as offers loans and various forms of insurance to customers and dealers. It also offers financing for vehicles, power generation facilities and marine vessels.

The key factor for Caterpillar is the overall economy. If the economy is humming along, then things are being constructed. And if things are being constructed, it probably means some of that construction equipment is being financed. If the economy is tanking, the situation is reversed. Some of this is blunted because America always farms, so the farming equipment side is somewhat protected. Nevertheless, Caterpillar essentially is a cyclical business, so if you are going to be in the stock, you better be in it for the long term. The good news is that the economy is improving in the areas that Caterpillar services, so things are looking up.

This is reflected in stock analysts’ five-year outlook on Caterpillar, which sees annualized earnings growth at 17.5%, but that includes a 61% earnings increase in 2011 and another 35% increase expected in FY 2012. That suggests low or no growth after that. At a stock price of $85, on FY 2011 earnings of $6.68, the stock presently trades at a P/E of 13. CNH Global (NYSE:CNH) is the closest competitor at a P/E of 9, so there’s a minor suggestion that Caterpillar is overvalued, but not much.

Caterpillar carries $10.7 billion in cash, and $25.9 billion in debt at a blended interest rate of only 1.6%. Trailing 12-month cash flow was $3.4 billion, so the debt service is no problem. The company also had 3.9 times the amount of free cash flow necessary to pay its 2.2% dividend. So CAT appears to be on solid footing financially.

Caterpillar has had two insider purchases of about 3,000 shares in the past year. That’s not a huge endorsement, but it is better than nothing.


Placing a 17 P/E on Caterpillar, with projected 2015 earnings of $9.50 per share, gives us a price target of $162. Add in reinvested dividends, and that suggests about a 110% total return. The trick is how will Caterpillar fair after these next two years of mega-recovery off the recession lows? What happens if we fall into a double-dip? Fortunately, I’d say that since the company trades at a 13 P/E compared to 17.5 where it might be arguably valued, there’s enough margin for error to make it a buy.

I believe Caterpillar is a buy for regular accounts.

I believe Caterpillar is a buy for retirement accounts.

Lawrence Meyers does not own shares of Caterpillar.

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