Is Caterpillar Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Caterpillar (NYSE: CAT  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Caterpillar's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Caterpillar's key statistics:

CAT Total Return Price Chart

CAT Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

78.3%

Pass

Improving profit margin

50.7%

Pass

Free cash flow growth > Net income growth

(3.9%) vs. 168.8%

Fail

Improving EPS

158.8%

Pass

Stock growth (+ 15%) < EPS growth

54.3% vs. 158.8%

Pass

Source: YCharts. * Period begins at end of Q2 2010.

CAT Return on Equity Chart

CAT Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

31.3%

Pass

Declining debt to equity

(29.3%)

Pass

Dividend growth > 25%

36.4%

Pass

Free cash flow payout ratio < 50%

47.6%

Pass

Source: YCharts. * Period begins at end of Q2 2010.

How we got here, and where we're going
Caterpillar puts together an extremely strong performance, earning eight out of nine possible passing grades. It missed out on a perfect score because of falling free cash flow, which has diverged from its net income over the past three years, and which threatens to undermine the health of its dividend payments. Will Caterpillar to able to move past this problem? Let's dig a little deeper to find out.

Last month, Caterpillar disappointed investors by missing on both the top and bottom lines in its latest earnings report. The company's revenue fell 16% year over year, and double-digit declines are never a good sign for a company widely viewed as a construction and industrial bellwether. Caterpillar's resource industries, primarily devoted to mining, suffered a terrible 34% drop year over year as the global mining industry continues to suffer through brutal price declines across a range of earth-bound commodities.

Despite this weakness, Caterpillar recently launched an accelerated $1 billion capital-return plan that should boost shareholder confidence in the company's core business activities. With signs of relative strength in the United States offering some breathing room, Caterpillar has decided to keep an eye on its international markets, especially its mining and construction segment, which now comprises 70% of its total revenues. Fool contributor Dan Caplinger notes that Caterpillar has managed to maintain $20.4 billion in order backlog in spite of its present weakness.

Putting the pieces together
Today, Caterpillar has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

With the U.S. relying on the rest of the world for such a large percentage of our goods, many investors are ready for the end of the "made in China" era. Well, it may be here. Read all about the biggest industry disrupters since the personal computer in 3 Stocks to Own for the New Industrial Revolution. Just click here to learn more.


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Comments from our Foolish Readers

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 August 19, 2013, at 10:14 AM, jjvors wrote:

    Good analysis. Much of the cash flow drop is due to dealers reducing their inventories as a result of improved product distribution processes from Caterpillar. This will return the cash during the next up cycle.

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