As the Dow Reaches New Highs, What’s Holding Back These Stocks?

The Dow Jones Industrial Average (DJINDICES: ^DJI  ) made history last week by hitting a new historic high of more than 16,000. Despite this news and expectations of continued financial easing if Janet Yellen is chosen to lead the Federal Reserve, there are still a couple of businesses on the Dow that have actually seen their stock prices drop over the past year, as many of their peers are reporting huge positive returns. What's behind this move, and should investors see it as a sign to jump ship from these businesses?

Slow-moving Caterpillar
Last quarter was full of bad news for mining and construction equipment giant Caterpillar (NYSE: CAT  ) , whose overall returns are down more than 6% year to date. Everywhere investors look, metrics seem to be dropping, from revenue (down 18% to $13.4 billion) to equipment demand to year-end earnings guidance, which was cut from a range of $56 billion to $58 billion down to $55 billion.

That earnings call was the latest in a string of bad news for Caterpillar, and CEO Doug Oberhelman was the first to admit that 2013 "has proven to be difficult." The company's earnings release explained that Caterpillar is suffering from a one-two punch of lower demand for mining since 2012 and difficulty gauging demand for top-selling Caterpillar equipment because of both "weak orders and feedback from end users."

While some factors of Caterpillar's decline are beyond the company's control, there are a few red flags on its financial statements that could be cause for alarm. Besides a drop in sales, Caterpillar has also lost some ground on its ability to retain profit margins. Operating profit margin is down from 15% in Q3 2012, to 10% this past quarter, or $1.4 billion. Net profit margin, meanwhile, is down from 10% last year to 7% this Q3, or $946 million.

One bright spot for Caterpillar right now is China. As the construction industry continues to grow there, Caterpillar saw sales in that segment increase 30% last quarter, to $800 million. That amount was reportedly more growth than any of its top competitors saw within the country.

While a difficult year in sales might not be a death sentence for a company, investors who absolutely feel compelled to hold part of the mining and construction industry might continue to see difficulties with Caterpillar going into 2014. Keep an eye on how the industry shifts, and whether the company's hold on China strengthens, before doing making any drastic moves with this stock.

International Business Missteps
The only other company on the Dow that's seen a drop in returns this year is IBM (NYSE: IBM  ) , and its struggles have been widely publicized as losing Warren Buffett a great deal of money -- $400 million, to be exact. Last quarter, IBM saw revenue dip 4% to $23.7 billion, which sent its stock plummeting 7.4% in a matter of days. CEO Ginni Rometty, however, was still optimistic, explaining that last quarter, every opportunity IBM "pursued aggressively" resulted in its favor, with high growth.

Sure enough, while many IBM segments were down, revenue for business analytics and cloud services -- two segments that Rometty cited as proactively pursued growth targets -- were up 8% and over 70%, respectively. IBM's profit margins have been growing, too, with net income growing from $3.8 billion to $4 billion, even in the wake of dropping sales.

There may be more reason to Buffett's stake in a stalled-out company than first meets the eye. The legendary investor revealed his IBM holding in November 2011, and claimed that much of his reasoning was for the company's 2015 road map, which is aiming to generate $8 billion through an "enterprise transformation," turn software into half of its segment profit, and return $70 billion to shareholders. As fellow Fool Dan Caplinger has pointed out, Buffett has actually purchased more of IBM since then, even as the company goes through a rough spot. Having an ambitious itinerary for the next few years doesn't hurt.

Drops of the Dow
These businesses might have struggled while other Dow darlings saw success, but that doesn't necessarily mean they're beyond hope as investments. Both Caterpillar and IBM have plans to dust themselves off and get back on the right track.

That said, it might take a while (perhaps one or two years) before either Caterpillar or IBM reaches the high-yielding returns of some of its Dow brethren. For someone looking to hold a long-term underdog story, this could be a good option, but someone of a less steely investor stomach might want to look elsewhere.

Time to get invested
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Related Tickers

11/26/2014 4:31 PM
^DJI $17827.75 Up +12.81 +0.00%
DOW JONES INDUSTRI… CAPS Rating: No stars
CAT $105.79 Down -0.45 +0.00%
Caterpillar, Inc. CAPS Rating: ****
IBM $161.95 Up +0.19 +0.00%
International Busi… CAPS Rating: ****

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