Let me make sure I’ve got this straight — Caterpillar (NYSE:CAT) falls short of its earnings estimate, then lowers its guidance, and the market rewards the company by pumping its stock up?

Sounds about right.

There’s usually “more to the story” when it comes to handicapping stocks — some pieces of evidence buried deep in the numbers or the executives’ words. So what’s the rest of the story with Caterpillar?

Vital Stats

Most of the time there’s at least one bright side to a company’s numbers, even if they’re ugly as whole. Caterpillar’s Q1 is an exception, though — there is no bright side.

Earnings fell from $2.37 per share in Q1 2012 to $1.31 for Q1 2013, and fell short of analysts’ $1.40 estimates. Revenue slumped from $15.98 billion to $13.21 billion this time around, missing forecasts of $13.71 billion.

Caterpillar also lowered its full-year sales outlook from a range of $60 billion to $68 billion to a range of $57 billion to $61 billion. Full-year earnings are also expected to be at the low end of the previously-suggested range, between $7 and $9 per share.

Again, there’s not a lot of silver lining for the optimists to work with.

Behind the Numbers

Truth be told, the “story” behind the demise of first quarter’s numbers isn’t exactly veiled. The company has been warning the market for weeks that most mining industries were contracting, and that this weakness would show up on the books.

Well, it did. In spades.

Caterpillar’s mining division’s operating profit fell 59%. The construction division’s operating bottom line slumped 61%. The power systems’ division was lower by 26% on a year-over-year basis.

The weak numbers reflect a drastic plunge in demand that materialized late last year. The machinery company was originally expecting a rebound in demand beginning in 2013, but halfway into the second quarter, that light at the end of the tunnel hasn’t appeared.

CAT conceded the point on Monday, detailing that its 2013 forecast for sales of mining equipment was about 50% lower than 2012’s already-depressed total. That hurts, as its big-ticket mining equipment are the highest-margin goods it sells.

Or as CEO Doug Oberhelman said, “our expectations for mining have decreased significantly.”

So what prompted CAT shares to surge nearly 3% on Monday in the shadow of bad news? That’s where things get interesting … and philosophical.

So Bad, It’s Good

Ever heard the phrase “buy the rumor, sell the news”? It’s a clever way of explaining how most news-based stock rallies actually unfurl before news becomes official, and once news becomes public knowledge, most of those buyers start to take profits, selling into the buying hands of all the late-comers.

Well, the opposite scenario also holds true: “Sell the rumor, buy the news.”

There was nothing surprising about what investors heard from Caterpillar yesterday — the market took the company’s warnings at face value beginning back in late January. The stock peaked at $99.70 before falling all the way to last week’s low of $80.01. That’s a 20% pullback in less than three months. Indeed, the 20% dip may have more than priced the worst-case scenario.

Even with Monday’s rally, the stock’s trailing P/E ratio is a mere 9.7. The forward-looking P/E ratio is a mere 9.3. Even adjusted for weaker earnings expectations, the projected P/E is only a tad above 10.0, and still below the norm for the industrial sector.

Translation: The sellers overshot between late January and last week. Now, Caterpillar shares are looking to correct the mistake.

Bottom Line

Logical or not, investor sentiment is like a pendulum — it never stops swinging from one extreme to the other, even if it loosely reflects the company’s underlying results.

The market was a little too optimistic about Caterpillar leading up to the late-January peak, responding to the company’s optimism that 2013 would see a bounce in demand. In the same way, when CAT announced early in the year that it wouldn’t actually see any rebound in demand anytime soon, traders again reacted with a little too much zeal.

Now that we’ve baked in the “as bad as it gets” scenario, that pendulum is once again swinging on the other direction. No clever interpretation is needed here; investors can take Monday’s hint at face value and use the recent low as an entry point into a new budding uptrend.

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