Which Industrial Powerhouse Is a Better Buy Right Now?

This is "Stock Smackdown," where two similarly positioned companies will go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, and dividend quality. We'll also take a look ahead at some more subjective measures -- Wall Street's analysts will get their say, but so will The Motley Fool's top market minds.

The winner will be the stock that racks up the most battle victories by the end of this competition. Now, let's go to ringside and meet our two combatants, General Electric (NYSE: GE) and Caterpillar (NYSE: CAT).

In this corner…
There are both significant overlaps and significant differences between these two companies. The latest tie-up pits Caterpillar and GE in a head-to-head battle for Asia-Pacific mining equipment dominance. The two companies have placed significant bets on Chinese growth, which puts both at odds with mining specialist Joy Global (NYSE: JOY). Both Caterpillar and Joy's existing mining business saw impressive year-over-year growth, an encouraging sign for GE's recent mining-equipment acquisition of Industrea.

GE's other enterprises are quite diverse -- so much so that some Fools have questioned whether it's too unwieldy to thrive. GE has shifted away from the finance operations that landed it in hot water during the housing crisis, but it's still got plenty of other varied segments. The company's ongoing investment in energy technologies has spread across both "green" and hydrocarbon-based developments. The company's scale hasn't helped it dominate the solar industry, but my fellow Fool Travis Hoium points out that a solar shakedown could deliver one-time segment standard bearer First Solar (Nasdaq: FSLR) into GE's hands at an appealing discount. GE's also started to make inroads into industrial software, which means it could one day be indirectly controlling many of Caterpillar's machines.

Caterpillar may not be as diversified, but it knows how to get the most out of its machinery. The company's resisted a long-awaited Chinese slowdown better than many expected -- certainly relative to close competitor Deere (NYSE: DE), which whiffed on its latest earnings while Caterpillar outperformed. Caterpillar was also this spring's Motley Fool Madness (it's like the Final Four, but for stocks) champion. International markets may be the company's undoing, but its status as a macroeconomic bellwether means that it might be as important to your portfolio as GE, even if you only hold a position in GE.

Valuation battle
We use many different numbers and ratios when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. We'll also check the same two ratios on a price-to-free cash flow basis. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric here at the Fool.

The difference between a stock's ratio today and its five-year average will be more important than the numbers themselves. Ratios currently lower than their averages may have more room to grow back to that middle ground.

For the tiebreaker, we'll check one less-used financial metric: enterprise value to earnings before interest, taxes, depreciation, and amortization. My Foolish colleague Matt Koppenheffer has a good explanation of this metric's usefulness at the link in the last sentence, but the short explanation is: the lower, the better.

Sources: Wolfram Alpha and YCharts. Winners in bold.

It looks like GE takes this round with a better level of debt to equity and some low price-to-free cash flow ratios. Can Caterpillar fight back to win the earnings quality round?

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at each company's operating and net margins, five-year annualized rates of earnings growth, and streaks of both profitable years and improving profitability. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.

Sources: Yahoo! Finance, Morningstar, and Wolfram Alpha. Winners in bold.

2009 wasn't kind to either of these companies, which explains why neither has more than three straight years of earnings growth. But thanks to two ties and two victories, Caterpillar takes this round with a shaky TKO.

Dividend battle
A growing company is great, but one that pays you back is even better. Let's see how strong and stable each company's dividends really are. We'll examine yield and two payout ratios, both the standard net-income-based ratio and free cash flow payout ratios. We'll also examine each company's five-year annualized dividend growth rate and streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.

Sources: Morningstar, Dividata, and corporate investor relations. Winners in bold.  Based on 2011 annual results.

GE is serious about its dividends. This might be a bit unfair to Caterpillar, since its dividends have at least maintained positive growth in recent years, but it has a chance to even things up when the analysts have their say.

Battle for the future
How do the world's most engaged market participants view these companies? Let's see what Wall Street's analysts expect, and what our Motley Fool CAPS community thinks.

Sources: Yahoo! Finance, Motley Fool CAPS.

In the end, GE ekes out another narrow victory to take this competition by a three-to-one margin. The closeness of this competition means Caterpillar's still a force to be reckoned with, and it may still merit a closer look.

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