CAT: Can Caterpillar Stock Dig its Way Out?

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Caterpillar Inc. (CAT) has been hit and hit hard. The world’s largest construction and mining equipment maker has found itself in the midst of a commodities meltdown.

CAT stock That same meltdown has hit CAT’s clientele, namely miners and other commodity producers, from around the world. Of course, that means those producers are under pressure to reduce not only costs, but output. That’s because it makes no sense to produce more when the market is already flush with supplies.

That cost-cutting exercise has included investments in Caterpillar-produced equipment. Of course, that resulted in Caterpillar’s revenue base declining by more than 30% year over year in 2015. Naturally, this has led CAT stock to trade at its cheapest value in quite a while.

But, does that make it a bargain? If we take a clue from Warren Buffett, then you’ll see that CAT stock can certainly be considered a bargain.

CAT Stock and the Warren Buffett Rule

One of my favorite pearls of wisdom from the Oracle of Omaha, Warren Buffett, is to buy the stock of a solid company in temporary distress because, eventually, companies that are solid, and that are also industry leaders, tend to recover quickly. When the situation improves, the stock valuation reverts to its average, and those who invested in the stock during that temporary distress will have gained.

But, is that the case for CAT stock?  Yes and here’s why:

Market share: Caterpillar is a very well-managed company. In nearly every category in which the company is active, it’s either the industry’s biggest or among the top three. That clearly demonstrates a very strong understanding of what its clients need. Moreover, it speaks to very effective marketing and selling abilities.

Not only that, but according to the company’s own reports, it uses the latest market weakness to further marginalize its competitors. That way, CAT gains even more market share. Caterpillar is a classic distinction of a solid company that knows how to tip the scales in its favor.

Caterpillar finances its clients: Another point of strength for CAT stock is that Caterpillar has a very effective funding arm. In fact, quite often, its clients prefer to use Caterpillar financing over traditional lending.

That can be a win-win situation for CAT stock price. Under a Caterpillar financing agreement, if the customer defaults on a loan, Caterpillar can seize the equipment. Unlike a bank, CAT can actually make good use of repossessed equipment by selling it on the resale market.

Caterpillar’s R&D: Caterpillar invests roughly $2 billion in R&D in absolute numbers, which is the highest in the industry by far. This allows Caterpillar to consistently develop and manufacture better, more efficient, and productive equipment. That investment in R&D underpins Caterpillar’s dominance in the market, now and for the foreseeable future.

Strategy for CAT Stock

At the moment, Caterpillar stock is trading at a P/E ratio of 13.5x, compared to its 5-year average of 18x. It’s true, though, that the company still faces some headwinds; even according to its own guidance, revenue is expected to plunge by approximately 5% next year. While a plunge of 5% in revenue next year is not encouraging it may signal that the worst is over for Caterpillar’s business.

Of course, there are more headwinds to CAT stock in the near term. Thus, the best way to be both upbeat and somewhat prudent to the risks ahead is to buy the stock in a dollar-averaging method, which will reduce some of the risk.

Be patient until CAT stock can finally dig its way out of the mud. Then, it should return to its long-term valuation average of an 18x P/E ratio, 33% higher than where it’s currently trading.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/12/can-caterpillar-cat-stock-dig-way-out/.

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