Caterpillar (CAT -2.42%) and Stanley Black & Decker (SWK -0.70%) may both be industrial stocks, but their performance over the past year or two couldn't be more different.

Caterpillar is hovering right around its all-time high, while Stanley Black & Decker is down 63% from its all-time high and is trading near a 10-year low. 

Let's dive into the bull case for both companies and let you decide which is the better buy now.

A welder working on top of a steel girder.

Image source: Getty Images.

Caterpillar stock is still cheap

Daniel Foelber (Caterpillar): One of the easiest mistakes investors make is letting the price action of a stock determine if it's expensive or on sale. Using that logic, one look at the charts for Caterpillar and Stanley Black & Decker, and the reaction would be to sell Caterpillar and buy gobs of Stanley Black & Decker.

Investing is more complicated than that. While it's true that some stocks go up for speculative reasons that aren't supported by fundamentals, Caterpillar stock deserves to be at an all-time high. For starters, its stock was too low for too long, and the market is finally catching up to a more reasonable valuation for the earth-moving equipment and machinery manufacturer.

Another reason is that Caterpillar's valuation is still cheaper than the broader market. Its forward price-to-earnings ratio is 16.9, which is less than Stanley Black & Decker's forward P/E of 18.4 and the aggregate P/E of the Dow Jones Industrial Average (20.9).

Investors may be scratching their heads as to how a stock that is at a 10-year low can actually be more expensive than a stock that is at its all-time high. The answer is that Caterpillar and Stanley Black & Decker serve completely different customers in the industrial sector. No one is going to Home Depot and buying a Caterpillar engine that could fill a small room. But they are buying Stanley Black & Decker products. In this vein, Stanley Black & Decker has much more exposure to the health of the consumer, while Caterpillar's dealers sell to businesses that are undergoing a growth cycle right now. 

The disconnect may not last forever. And if growth slows, Caterpillar stock could look more expensive than it does today. It's also worth mentioning that Stanley Black & Decker's earnings are down, and the company is undergoing a restructuring to manage costs. If it goes well, the stock could be a nice turnaround play.

The investment thesis for Stanley Black & Decker is compelling for investors that are willing to wait. But Caterpillar has more going for it and could sustain a multiyear growth cycle. That level of certainty and the fact that the stock is still inexpensive make Caterpillar a better all-around buy, even though its dividend yield of 2.1% is less than Stanley Black & Decker's 4% yield.

A worthy turnaround play

Lee Samaha (Stanley Black & Decker): The case for buying Stanley Black & Decker stock over Caterpillar stock rests on the idea that the former is a better value on a risk-reward basis. Caterpillar is undoubtedly the higher-quality stock, not least because the company is achieving its strategic objectives and financial targets. For example, on its investor day presentation this year, management affirmed it had broadly met its goals laid out in 2017 of increasing its profit margins and free cash flow (FCF) through the cycle.

The company's mix of construction, mining, energy, and transportation machinery means it will always be a cyclical company with fluctuating earnings, so management aims to increase the ranges of its earnings and FCF through the cycle. 

But here's the thing: Management's ranges for machinery, energy, and transportation equipment FCF is $4 billion to $8 billion. Using the midpoint of the range of $6 billion and Caterpillar's current market cap of $120.6 billion gives a price-to-FCF multiple of 20 times FCF -- a figure often seen as fair value for a mature industrial conglomerate. Therefore, Caterpillar's stock only has a significant upside provided you believe in an extended cycle of spending in the energy, construction, and mining industries. 

In contrast, Stanley Black & Decker has had a miserable year. Cost pressures and supply chain issues extended far more than expected, and rising interest rates are slowing the housing market and underlying demand for its DIY tools. Thus, management now expects full-year adjusted earnings per share of just $4.15 to $4.65, having started the year expecting $12 to $12.50.

The declining fortunes are reflected in the share price decline of 57% in 2022. That said, management is launching a restructuring program to cut costs by a whopping $2 billion in three years. Suppose management is successful and can work through its inventory problem (reducing inventory in a weak sales environment without suffering significant margin erosion). In that case, the stock could be an excellent investment for patient investors.

A dynamic duo worth considering now

Caterpillar and Stanley Black & Decker could both be worth buying now. Caterpillar has better growth prospects. But Stanley Black & Decker could hit its growth cycle while the growth cycle for Caterpillar goes down. Both stocks are at a reasonable valuation. And buying equal parts of each gives an investor a 3% dividend yield and exposure to different parts of the industrial sector.

What's more, both companies have a track record for consistent dividend raises. Caterpillar is a Dividend Aristocrat that has paid and raised its dividend for 29 consecutive years, while Stanley Black & Decker is a Dividend King that has paid and raised its dividend for 55 consecutive years.