Caterpillar (NYSE:CAT) has struggled in 2018 as trade war fears loomed over the company. Despite impressive levels of earnings and revenue growth, CAT stock trades at more than 23% below its 52-week high.
However, following its earnings report in October, Caterpillar stock has surged. It now trades 18% more than its post-earnings low.
Investors often show reluctance to buy into such rallies. However, many factors indicate that prospective buyers should open positions in CAT stock following this bounce.
Caterpillar Isn’t All About the Trade War
The constant need to expand, repair, and upgrade America’s infrastructure gives Caterpillar a book of built-in business. Still, the stock traded down on the reduced growth a trade war with China brings.
Now, with impressive revenue and earnings growth, the stock appears to have begun a recovery phase. Caterpillar fell to a low of just above $112 per share in following earnings. Two weeks later, the CAT stock price now stands at about $132 per share. I think buyers made the right call in bidding up the price. The improved outlook indicates the trade war fears have become overdone.
China faces a growing incentive to end the trade war. When comparing the stock markets in the U.S. with those in both Hong Kong and Shanghai, the Chinese markets have borne the bulk of the suffering.
The Hang Seng Index has fallen by about 20% from its high, while the Shanghai Composite index has seen a drop of around 25%. In comparison, the S&P 500 has fallen less than 6% from its 52-week high. This increases the likelihood that China will accept any face-saving agreement to end this war. At that point, CAT stock will benefit further.
Oil, Gas and Caterpillar Stock
Additionally, investors so deeply associate Caterpillar with construction that they forget the importance of the oil industry. As our own Dana Blankenhorn pointed out, the 2014-16 oil price slump took the revenues of Caterpillar down by one-third.
Now, with oil prices recovering, exploration and production activity also has resumed. With that, Wall Street forecasts revenue growth of 20.5% for this year. That would take revenues to an estimated $54.76 billion, a level just shy of 2014 highs.
The predicted 7% revenue increase for 2019 would bring revenue levels to record highs. Also, while Komatsu (OTCMKTS:KMTUY) and Terex (NYSE:TEX) compete in this industry, this industry has few players.
A Bright Outlook
These factors have led to progress on the profit front. Thanks to the estimated 69.2% surge in profits for this year, the price-to-earnings (PE) ratio for 2018 has fallen to 11.2.
Wall Street also predicts earnings of $12.84 per share for next year. Compared to today’s prices, that takes the forward PE to just above 10. They also forecast average annual profit growth of 26.35% per year for the next five years.
Caterpillar has not seen an average PE ratio in the single digits since 2008. Hence, I can see this stock moving higher on valuation alone.
Investors should also pay attention to the CAT dividend. While the company declines to increase the dividend in some years, it has seen an upward trend since 2005. The annual payout has reached $3.44 per share, a yield of just over 2.6%. Given the increasing profits, investors can probably expect yearly increases for the foreseeable future.
The Bottom Line on CAT Stock
Numerous factors point to a bright, near-term future for Caterpillar. I believe the trade war that has unjustly taken down the stock will likely end soon. Even if the trade war continues, a recovery in energy prices has improved its lesser-known but vital stake in the oil and gas industry.
Moreover, revenue increases indicate that both profits and dividends will surge to record highs. As investors compare this to a forward PE ratio that flirts with the single digits, investors will likely see that CAT stock will continue to build profits and cash flow for their portfolios.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
