How Dividends Change the Game for Caterpillar Stock

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The wealth-building power of compound interest will never cease to amaze me. It's a story of patience and attention to detail, where small, short-term differences add up to massive divergence over decades. And in the end, the biggest winners don't always deliver the fattest share-price returns.

Caterpillar (NYSE: CAT  ) happens to be the biggest gainer on the Dow Jones Industrial Average (DJINDICES: ^DJI  ) today. The stock has jumped 3%as of 1:50 p.m. EDT, helped by positive news on the Chinese economy. The Middle Kingdom is an important market for the construction machinery maker, and Chinese sales have not been healthy lately. 2013 revenue from this region was recently guided toward half of what it was in 2011. So good economic news out of China always helps Caterpillar.

That being said, Monday's healthy jump doesn't make up for a disappointing performance in 2013 as a whole. Caterpillar has underperformed its Dow peers by a wide margin this year:

CAT Chart

CAT data by YCharts.

It doesn't even help Caterpillar investors much if you assume that every dividend was reinvested in more shares. With dividends reinvested, Caterpillar stock has still notched a 2.9% loss so far this year, while reinvesting dividends in a Dow tracker such as the SPDR Dow Jones Industrial Average (NYSEMKT: DIA  ) scored a 15.9% gain. Yes, Caterpillar pays a dividend yield slightly above the 2.7% Dow average. But a slight edge in dividend yields doesn't make a huge difference in the short run.

But wait a minute. Caterpillar has also grown its payouts faster than the Dow average over the last 10 years, so the currently high yield is no flash in the pan. How does that trend change the long-term value to Caterpillar investors?

CAT Chart

CAT data by YCharts

Quite a bit, as it turns out. Reinvested dividends have boosted the average Dow stock's returns by about 19% over the last decade. For Caterpillar's stock, the difference is more like 44%.

It also doesn't hurt at all that Caterpillar shares have trounced the market in the long term, with or without dividend boosts. The company is incredibly well-managed, and the business rests on solid cash flows to boot. Even when sales drop drastically, as they did in the panic of 2008, Caterpillar still squeezes out a dependable stream of free cash.

CAT Free Cash Flow TTM Chart

CAT Free Cash Flow TTM data by YCharts.

In short, Caterpillar presents a fantastically dependable dividend under almost any circumstances. While the stock's performance in 2013 has been frustrating, the low prices also give investors a chance to lock in high effective yields while the discount lasts.

Caterpillar may be one of the Dow's strongest dividend plays, but it's far from the only income-generating slam dunk among the index's 30 elite tickers. If you're looking for more long-term investing ideas, you're invited to check out The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so simply click here now and get your copy today.


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