Better Dividend Stock: Caterpillar Inc. or Deere & Company?

To proclaim that dividend stocks are a critical component of every portfolio is probably a huge understatement. Dividends, and the ability to reinvest those dividend payments over time, can be the difference between simply retiring and retiring comfortably, the way you want.

Of course, not all dividends are created equally. Some dividends are simply so small you'll need a microscope to analyze them, while others might be unsustainable due to either an overzealous payout ratio or a deeper flaw in the underlying business model. In order to decipher whether or not a dividend is truly investment-worthy we need to be able to dig beneath the surface and examine the growth, value, and sustainability of not only the dividend itself, but the business behind the dividend.

The farm and heavy construction industry, for example, is a haven for dividend investors, with all 12 companies valued over $400 million paying a dividend, including Caterpillar (CAT 0.05%) with its 3% yield and Deere (DE -0.56%) with an equally impressive 2.8% yield. Yet yield alone doesn't tell us much. That's why we'll take a closer look at the growth, value, and sustainability of the payout and business model of these two companies to determine which truly is the better dividend stock.

Growth

I know what you're probably thinking, and you're correct: "Growth" is sort of a misleading term for both Caterpillar and Deere at the moment.

Source: Caterpillar.

Caterpillar delivered not one, not two, but three profit warnings last year as full-year revenue declined 16%. The catalyst for Caterpillar's sales slump has been unrelenting weakness in commodity prices such as oil and coal, which has caused a dip in the need for heavy machinery to recover these commodities. This year, Wall Street is expecting Caterpillar's revenue to decline by a modest 1%, though it should return to top-line growth in fiscal 2015.

Deere is facing a less steep decline in its revenue relative to Caterpillar, but it'll likely be more drawn-out, with Wall Street anticipating sales declines starting in 2014 and continuing through 2016. Deere's woes can be tied to lower farm income than in 2013, which is pressuring farmers' ability to purchase new equipment. Additionally, weakness in South American demand is also expected to weigh on Deere for the foreseeable future. 

Source: Deere.

Yet both companies remain healthfully profitable, have excellent pricing power because of their geographic dominance and size, and are poised to return to growth over the long run. Deere's focus on crops places it at the center of a much-needed and finite resource, while Caterpillar's dominance in mining and construction equipment allows it to take advantage of finite natural resources and the need to accommodate a growing population vis-a-vis increasing global construction projects.

Though I'm really splitting hairs here, I don't want a tie and am going with Deere as the slightly more attractive growth play despite its near-term revenue weakness. Deere's focus on a basic-need good (food) gives it a slight leg up on Caterpillar, which has a primary customer who is focused on goods more prone to price fluctuations.

Value

In addition to finding a company with good growth prospects, dividend-seeking investors want to purchase a company they perceive to be a good value. Let's have a look at some of the pertinent value metrics between Caterpillar and Deere to determine if one company stands out.

Source: Yahoo! Finance. TTM = trailing 12 months.

As it turns out, Caterpillar and Deere are incredibly similar with regard to their valuation, which I guess isn't a huge shock considering they're in the same sector and often compared to each other. Despite identical price/book ratios and essentially identical forward P/E ratios, the primary differentiating factor here, and why I believe Caterpillar is the more attractive of the two on a valuation basis, is the PEG ratio.

The PEG ratio takes into consideration a company's current price-to-earnings ratio, which measures how well it's done over the previous four quarters, and divides that figure into its estimated growth rate over a specific time period (most often five years). In this case, Caterpillar's significantly lower PEG ratio would imply that it has a much higher projected growth rate over the next five years than Deere. Based on that, I'd give Caterpillar the slight edge in this category.

Sustainability

Finally, income-seeking investors want to buy companies that can maintain and grow their dividend over time. In this instance we're talking five, 10, or even 20 years down the road.

The good news is that Caterpillar and Deere are both dividend juggernauts when it comes to sustainability. Since 1996, Caterpillar's dividend has jumped by 600%, to $0.70 per quarter from just $0.10. On the other hand, looking at Deere since 1996 (to keep this comparison apples-to-apples), the company has grown its dividend by 500%, to $2.40 annually from $0.40.

CAT Dividend data by YCharts.

Both companies, as we've established above, also have size and geographic diversification on their side, which means both present favorable long-term business outlooks.

The differentiating factor here, as I see it, is the dividend payout ratio, which in plainer terms tells us how much profit the company is willing to return to shareholders. Though Deere has delivered more impressive dividend growth in recent years, Caterpillar has consistently paid out a greater portion of its profits to shareholders, which I find far more appealing. Projected to pay out just 39% of its 2015 EPS, Caterpillar has plenty of room to further boost this payout, especially considering that Caterpillar has averaged nearly $2.8 billion in free cash flow since 2005.

The better dividend stocks is...

After carefully weighing both heavy-duty machine manufacturers, and noting the extreme similarities between the two with regard to their valuations and growth prospects, I'm willing to declare Caterpillar the better dividend stock. Caterpillar offers a slightly higher yield than Deere and shares more of its profits with its shareholders, and management has done a fantastic job of proactively managing expenses during the downturn.