Stock market volatility has eased up just a bit as investors digest interest rate increases and growth stocks begin to rebound off the lows. However, there are still a lot of risks in the market right now and no one knows what could happen in the short term. Given the business climate, some investors may be looking for safe dividend stocks to diversify their portfolios and smooth the rough edges. If that's you, then you've come to the right place.
Caterpillar (CAT 3.07%) stands out as one of the safest stocks out there. Here's what makes it a great buy now.
Image source: Getty Images.
Caterpillar's business is ready to boom
Most folks know Caterpillar for its earth-moving equipment, mainly in the construction industry. But Caterpillar actually generates more revenue from its resources industries (mining) and energy and transportation (oil and gas) segments than from construction and agriculture. Exposure to the construction, oil and gas, agriculture, and mining sectors makes Caterpillar one of the best-positioned businesses in today's economy.
The conflict in Europe has put a lot of pressure on the global agricultural industry, the oil and gas industry, and commodities and base metals. According to the International Trade Administration, "In 2019, Russia was the world's largest producer of barley; the third-largest producer and the largest exporter of wheat; the second-largest producer of sunflower seeds; the third-largest producer of potatoes and milk; and the sixth-largest producer of eggs and chicken meat." Ukraine is also a major exporter of grains. And we all know Europe's dependence on Russian oil and gas is a major geopolitical concern right now.
Pair these geopolitical risks with ongoing supply chain issues, and you have a coiled spring for countries to veer away from globalization and do more within their own borders. Caterpillar stands to benefit as countries move away from untrustworthy exporters and look to produce food, energy, and raw materials domestically.
It's too early to tell if there will be lasting effects from the Russia-Ukraine conflict and supply chain challenges. But if there are, investors looking for a play on increasing oil and gas, agricultural, mining, and construction investment in North America, China, South America, and the Asia Pacific region may find Caterpillar's business attractive.
NYSE: CAT
Key Data Points
Caterpillar is a passive income machine
Despite Caterpillar's short-, medium-, and long-term potential, it's important to remember that we are living in unique times. In general, Caterpillar's exposure to agriculture, construction, oil and gas, and mining make it a cyclical company that tends to boom and bust with the global economy. But Caterpillar offsets that cyclicality with a stable and growing dividend and a strong balance sheet. Caterpillar is one of the few cyclical companies that is a Dividend Aristocrat, a member of the S&P 500 that has paid and raised its annual dividend for at least 25 consecutive years. Caterpillar has done so for 27 years and has a dividend yield of 2%.
What it means to be a "safe stock"
When we think about safe stocks, we tend to think of large, blue-chip companies with stable earnings and cash flows. Businesses that have been around for a while are either resistant to economic downturns or have the staying power to weather the storm.
Quintessential safe stocks would be companies like Procter & Gamble or McDonald's. Today, you could even say that a company like Apple or Microsoft is a safe stock because they are both extremely profitable and growing businesses that provide "essential" products and services.
The unconventional safe stock
Cyclical companies, like Caterpillar, are usually not considered safe stocks. These companies tend to have big swings in their revenue and earnings, making some years look amazing and others look pretty bad. Despite Caterpillar's diversified businesses in both the industries it serves and the geographies it operates in, the historical performance indicates that Caterpillar is vulnerable to big swings in its earnings.
CAT Revenue (Annual) data by YCharts.
Over the past 10 years, Caterpillar's revenue, net income, and free cash flow (FCF) have varied drastically. Its highest revenue year was 2012, and the lowest was 2016. The highest net income year was 2021, and the lowest was 2016. And the highest FCF year was 2013, while the lowest was 2012. What's more, high revenue, as in 2012, didn't necessarily correlate to high earnings and FCF.
A better business
Caterpillar has made its business a lot more efficient in recent years. Part of the reason for its high earnings and FCF in 2021, despite ongoing supply chain challenges, a tight labor market, and COVID-19 issues is Caterpillar's lower spending.
CAT Capital Expenditures (Annual) data by YCharts.
Capital expenditures and operating expenses have come down a lot in the last decade, but Caterpillar's operating margin has remained strong, a sign that Caterpillar is converting more sales into operating income. Throughout both the U.S.-China trade war peak of 2018 and the COVID-19 peak in 2020, Caterpillar retained a solid operating margin -- a sign the business is in good shape.
The best of both worlds
Buying a stock solely for short-term gain is a risky endeavor. What makes Caterpillar special is that it has several short-term tailwinds but also has proven to be a long-term winning business and a great passive income stream for dividend investors over time. This unique blend makes Caterpillar an incredibly attractive business worth considering now.
