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%

7.9%

Fail

 

1-year revenue growth > 12%

9.5%

Fail

Margins

Gross margin > 35%

27.4%

Fail

 

Net margin > 15%

8.6%

Fail

Balance sheet

Debt to equity < 50%

228.3%

Fail

 

Current ratio > 1.3

1.43

Pass

Opportunities

Return on equity > 15%

36.9%

Pass

Valuation

Normalized P/E < 20

11.94

Pass

Dividends

Current yield > 2%

2.1%

Pass

 

5-year dividend growth > 10%

7.9%

Fail

       
 

Total score

 

4 out of 10

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

Since we looked at Caterpillar last year, the company has given back one of the two points it gained from 2011 to 2012. Falling revenue growth was to blame, and the stock has felt the consequences, dropping about 15% over the past year.

Caterpillar has been feeling the pain of a sluggish global economy throughout the past year. The U.S. market has been slow to pick up steam, hurting its domestic equipment sales. Meanwhile, China has been a particularly tough market for Caterpillar, as slowdowns in the economy during the early part of the year led to reduced infrastructure and construction activity. Due to lower commodity prices, Rio Tinto (NYSE: RIO  ) and other big mining companies have cut back on production, and that has hurt both Caterpillar and rival Joy Global (NYSE: JOY  ) in their sales of mining equipment.

More recently, Caterpillar has started to see some signs of life. China's stimulus package will put about $150 billion into infrastructure plays, and Caterpillar should get its fair share of that money. Meanwhile, an improving housing market has started making people more optimistic about construction in the U.S. more broadly, and that should bode well for the company going forward.

Yet that will take a while to show up in the company's numbers. In its most recent quarter, Caterpillar's net income fell by more than half, and the company gave fairly weak guidance for the coming year. With General Electric (NYSE: GE  ) planning to boost its presence in the mining equipment area, even a rebound in the industry could require Caterpillar to work harder to maintain its leadership position.

For Caterpillar to improve, it needs a full global recovery to take shape. Until that happens, Caterpillar is likely to see volatility in both directions as macroeconomic tides ebb and flow in the years to come.

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.

Learn much more about how Caterpillar plans to take over the world's construction business with its impressive product line and popular brand. Our premium report has everything you need to know, including whether Caterpillar's stock is a buy right now. Don't wait; click here to access it now.

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


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