Has Caterpillar Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Caterpillar (NYSE: CAT  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Caterpillar.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 6.8% Fail
  1-Year Revenue Growth > 12% 47.8% Pass
Margins Gross Margin > 35% 26.4% Fail
  Net Margin > 15% 7.8% Fail
Balance Sheet Debt to Equity < 50% 233.2% Fail
  Current Ratio > 1.3 1.46 Pass
Opportunities Return on Equity > 15% 35.2% Pass
Valuation Normalized P/E < 20 18.36 Pass
Dividends Current Yield > 2% 1.7% Fail
  5-Year Dividend Growth > 10% 10.4% Pass
       
  Total Score   5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Caterpillar last year, the equipment maker has picked up two more points. A big pickup in revenue growth in 2011 combined with a more attractive valuation earned Caterpillar a midrange score of five.

The story of Caterpillar's success is pretty simple, and it's one that you can see duplicated throughout the agricultural sector. With high crop prices and strong growth in emerging markets, Caterpillar has simply gone where the profits are -- and has done a good job of bringing them home to investors. Yet shareholders haven't rewarded the company with a higher stock price, potentially creating a big value opportunity.

Of course, Caterpillar will have to keep dealing with competition. Deere (NYSE: DE  ) has also fought hard to innovate, with new agricultural equipment that incorporates technological advances and other innovations. Crane-maker Manitowoc (NYSE: MTW  ) already has a presence in both China and India and is now seeking to add Brazil to its list with a big crane-construction project under way there.

One big question is how the company's recent buyout of Bucyrus will affect results going forward. Mining activity has been strong, but Joy Global (NYSE: JOY  ) represents a constant threat. For the moment, though, strength in mining has been enough to support both companies, as well as engine-maker Cummins (NYSE: CMI  ) , which cited strong mining and energy markets as a key component for its own sales surge.

With all this, Caterpillar has some tailwinds pushing it forward. But it needs to keep working to boost margins and get its debt down to more manageable levels. If it can do that, Caterpillar could become a perfect stock in the future.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Caterpillar is just one stock that has serious long-term potential for investors, but it may not be the best one. Find some more attractive companies by accepting my invitation to receive the Fool's latest special report absolutely free. Inside, you'll learn the names of three promising stocks for the long haul. But don't wait -- click here and read it today.

Click here to add Caterpillar to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Joy Global. Motley Fool newsletter services have recommended buying shares of Cummins. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2012, at 2:15 PM, Buysider wrote:

    This story incorrectly says Caterpillar is in the agricultural sector and that its business has been helped by high crop prices. Neither is the case. The story also incorrectly says Manitowoc competes with Caterpillar. Manitowoc makes cranes. Caterpillar does not make or sell cranes and has never wanted to be in that business, as cranes are “above the dirt,” while Caterpillar’s competitive advantage is in products that are “on the dirt” or “in the dirt.”

    I’m hopeful that someday, those who write about Caterpillar will first find out what the company makes and what it doesn’t make. So far, that has not happened.

    Caterpillar does not make or sell farm equipment, nor does it participate in the farm equipment industry anywhere in the world. Caterpillar competes with Deere, but only in medium-sized and small construction equipment, where up to now Deere's geographical range has been limited to North America (on October 3 last year, Deere announced plans to begin selling its construction equipment in South America, with some of the machines coming from two new factories Deere plans to build in Brazil).

    Caterpillar has not had a presence in the farm equipment business since 2002. Caterpillar makes construction and mining equipment and also diesel engines and gas turbines for a variety of markets.

    Caterpillar sells small construction equipment that is used for land clearing, earthmoving, and material handling on farms, but that is a tiny portion of its business. Caterpillar does not make or sell farm tractors, combines, or other equipment used primarily for farming.

    Some of Cat’s independent dealers sell farm equipment, but that equipment is obtained from other manufacturers and carries their brands.

    It’s an understandable error, as there is a widespread misconception in the media and among investors that Caterpillar is in the farm equipment business. One can find a great many media articles and references that erroneously say that Caterpillar makes farm equipment. However, it does not.

    At one time, Caterpillar did make rubber-tracked farm tractors using a rubber-track technology it developed and introduced in 1987. At its best, that business represented less than 5% of Caterpillar’s sales. Caterpillar sold its rubber-tracked farm tractor line (called the Challenger) to AGCO in 2002.

    Some independent Cat dealers sell AGCO-made Challenger rubber-tracked tractors for farming and earthmoving uses. Some of those carry the Cat brand, but they are manufactured by AGCO for sale to Cat dealers, so Caterpillar itself receives no economic benefit from their sale, except as it strengthens its dealers vis-à-vis competitors’ dealers in the region.

    I have followed Caterpillar closely for 38 years, for 37 of those years as a sell-side machinery analyst. For confirmation of the above, check with Caterpillar’s Director of Investor Relations, Mike DeWalt, at 309-675-4548, or its head of Corporate Public Affairs, Jim Dugan, at 309-494-4100.

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Related Tickers

10/21/2014 1:07 PM
CAT $95.67 Up +1.64 +1.75%
Caterpillar, Inc. CAPS Rating: ***
CMI $134.10 Up +3.22 +2.46%
Cummins CAPS Rating: *****
DE $83.48 Up +1.28 +1.56%
Deere & Company CAPS Rating: ****
JOY $52.02 Up +0.88 +1.72%
Joy Global, Inc. CAPS Rating: ****
MTW $18.99 Up +0.68 +3.71%
Manitowoc Company,… CAPS Rating: ***

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