In this fundamental stock analysis, I will take a look at the Caterpillar stock and see if it is currently a good investment. There are also good reasons for this analysis. According to Bloomberg, the Trump administration is preparing a nearly $1 trillion infrastructure program. Most of the money will be spent on traditional infrastructure works, such as roads and bridges. Caterpillar will benefit massively from this, which does not mean that you should automatically buy shares in the company. The decisive factor is the fundamental valuation. In this analysis, I tell you whether the company is currently fundamentally a bargain or overvalued.
If you want such a “Fundamental Quick Stock Price” analysis of a specific company, just write in the comments which company you want me to analyze.
Let us first take a look at the company and its business model. Caterpillar is the world’s largest manufacturer of heavy building machinery. In addition to construction equipment, the company manufactures high-speed and medium-speed diesel as well as gas engines and industrial gas turbines. After it acquired Bucyrus International, Caterpillar became one of the largest manufacturers of both surface and underground mining equipment.
Caterpillar has already benefited massively from Trump’s actions, right after Trump was elected president. When it became clear that Trump would push the domestic infrastructure with stimulus programs, Caterpillar’s share price nearly exploded and rose from around $90 to almost $170.
And of course, you are wondering whether such results can be expected again now. You can never know for sure, though. But we can look at how the company is doing financially and how it is currently fundamentally valued. The results can then be used to check what upside potential or downside risk exists.
As you can see here, Caterpillar is a cyclical company whose revenues collapse in years of economic downturn. In the past quarter, revenue has declined again. However, the overall picture still shows strong historical growth. So the company knows how to make sales.
Because Caterpillar is a cyclical company, margins slumped dramatically in 2008/2009. I assume that a robust economic slump due to COVID-19 will lead to the same result. Operating margin and net margin will probably reach single digits. Something else will happen if Trump can quickly implement the stimulus package, and the first orders are placed. At least, you can see that the company is capable of surviving times of crisis. After short slumps in some quarters, the margin has always returned to its previous levels.
Caterpillar is a dividend aristocrat that has increased its dividend every year for 25 years. If you had bought Caterpillar shares ten years ago, you would now have a yield on cost of 6 percent. With a current dividend yield of 3.3 percent, the dividend yield is somewhat above its historical average.
The increases have also been very encouraging. The average dividend increase in the last ten years was 8.4 percent, in the five previous years 7.7 percent, and in the three past years 7 percent. Most recently, Caterpillar increased its dividend by even 15 percent. The current payout ratio is also very comfortable. Recently, Caterpillar has spent only 50 percent of its cash flow on dividends and only 40 percent of its profits.
The Price/Book Value ratio compares a company’s current market price to its book value. A value of 1 means that the price of a share corresponds precisely to the (proportionate) book value of the company. Accordingly, a ratio below 1 is a good sign for value investors. However, such gems are rather rare to find, and if so, it is worth taking a closer look as well. For example, companies that operate in a challenging market with poor prospects (e.g., tobacco or oil) can have a particularly low price/book value.
You can see here that Caterpillar is valued within its historical median. The price/book value ratio thus indicates a fair valuation.
Price / Cash Flow
The Price/Cash Flow ratio compares a company’s current market price to its cash flow. With this metric, you can check how many years it would take a company to buy itself with its yearly cash flow. With prices above $130 per share, Caterpillar appears to be undervalued in terms of cash flow per share.
Caterpillar’s debt ratio is currently 60 percent. In my opinion, this is a bit too much for a cyclical company. Besides, debt has fallen continuously in recent years. It is also worth noting that Caterpillar holds treasury stock worth over one-third of all its debt. However, the amortization power of just $2 billion after dividends is a little too weak, given the debt of over $60 billion.
Fair Value Calculation of Caterpillar
I like to use the following overview, which shows me several multiples. But above all, this overview shows me the historical adjusted results. You can see here that Caterpillar is reasonably valued. At the same time, however, the share price is heading for overvaluation. The reason for this is that profits, cash flow, and sales are expected to fall. But this could change as a result of the economic stimulus program. If Caterpillar’s business returns to the level of economic highs, then the stock is, based on its fair value, undervalued.
All in all, we can say the following about our stock pick today: I expect that the market will take advantage of the moment after Trump announced his $1 trillion stimulus package. Investors will likely push Caterpillar’s share prices. However, if the economic situation gets worse, there is also a downside risk. Nevertheless, you get a dividend aristocrat with above-average dividend yield and a relatively low payout ratio. The company is not a jewel, but at prices around $130 per share, there is still a good balance of opportunity and risk.
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