2 Wall Street Analysts Share Differing Views on Caterpillar Stock. Who Is Right?

Caterpillar (CAT -4.42%) is a cyclical stock, meaning its revenue, profit margin, profits, and cash flow tend to ebb and flow along with the economy. Its earnings can overshoot expectations when the economy is in growth mode and undershoot them when it is slowing.

Recently, two heavyweight analysts published opposing views regarding the stock. Morgan Stanley's analyst set a new price target is $327 with an equal weight rating, while J.P. Morgan's new price target is $435 with an overweight rating. The Morgan Stanley 12-month target suggests a 9% drop from the current price of around $360, while the J.P. Morgan target points to a 21% upside.

Caterpillar: The bull and bear debate

The case for buying Caterpillar relies on lower interest rates stimulating construction activity, ongoing benefits of infrastructure spending on its equipment, and higher commodity prices driving its mining machinery and energy equipment sales. If you are optimistic about these indicators, the stock is a buy.

The bear case is the reverse of all these things, or at least it argues that these factors won't be strong enough to propel the stock higher.

A third viewpoint on Caterpillar

Another case revolves around believing in the end market drivers that can improve Caterpillar's earnings (lower rates, infrastructure spending, higher commodity prices). Complicating matters is the fact that it's best to buy cyclical stocks when the market is not pricing in an optimistic scenario.

Caterpillar's fair value is around 20 times the midpoint of its free cash flow (FCF) generation through the cycle. Management's updated guidance calls for $5 billion to $10 billion compared to previous guidance of $4 billion to $8 billion.

The midpoint of the new guidance is $7.5 billion, implying a valuation of $150 billion, when the current market cap is $181 billion at a share price of $360. While Caterpillar has the potential to exceed earnings estimates this year, and momentum is behind the stock, the current entry point is not an excellent value for long-term investors aware of the cyclicality of earnings.