Caterpillar Stock Analysis

As mentioned in my previous post, I'm going to try and have 1 stock analysis report for some popular dividend growth stocks come out prior to their latest earnings release this week. Today we'll look at Caterpillar Inc. (CAT). Caterpillar was trading on Monday 7/23/12 at $81.84.

Company Background:

Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. It offers backhoe, skid steer, multi-terrain, track-type, and wheel loaders; track, wheel, and mini excavators; select work tools; track-type tractors; motor graders; pipelayers; and related parts for the heavy construction, general construction, mining and quarry, and aggregates markets. The company also provides electric rope and hydraulic shovels, mining trucks, wheel dozers, draglines, electric drive mining trucks, compactors, tunnel boring and underground mining equipment, drills, forestry products, highwall miners, off-highway and articulated trucks, paving products, wheel tractor scrapers, electronics and control systems, and machinery components for mine, quarry, forestry, paving, and tunneling applications. In addition, it offers reciprocating engine powered generator sets; integrated systems for the electric power generation industry; reciprocating engines and integrated systems and solutions for the marine and petroleum industries, and industrial applications; turbines and turbine-related services; and diesel-electric locomotives and components, and other rail-related products and services. Further, the company provides retail financing for its equipment, machinery, and engines, as well as for vehicles, power generation facilities, and marine vessels that incorporate its products; wholesale financing to its dealers and customers; and insurance services. Additionally, it offers component manufacturing, remanufacturing, and logistics services, as well as distributes other companies’ products. Caterpillar Inc. markets its products through its sales force, distribution centers, dealers, and distributors.

DCF Valuation:

Analysts expect Caterpillar to grow earnings 17.50% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $249.63. This means that at $81.84 the shares are undervalued by 67.2%.

Graham Number:

Over the last 12 months, CAT's EPS were $7.93 and it's current book value per share is $22.95. The Graham Number is calculated to be $63.99 which means that at $81.84 the shares are overvalued by 27.9%.

Average High Dividend Yield:

CAT's average high dividend yield for the past 5 years is 4.04% and for the past 10 years is 3.19%. This gives target prices of $51.45 and $65.22 respectively based on the current annual dividend of $2.08. These are overvalued by 59.1% and 25.5%, respectively.

Average Low PE Ratio:

Caterpillar's average low PE ratio for the past 5 years is 10.58 and for the past 10 years is 11.15. This would correspond to a price per share of $100.98 and $106.37 respectively based off the analyst estimate of $9.54 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are undervalued by 19.0% and 23.1%, respectively.

Average Low P/S Ratio:

CAT's average low PS ratio for the past 5 years is 0.63 and for the past 10 years is 0.71. This would correspond to a price per share of $67.66 and $76.26 respectively based off the analyst estimate for revenue growth from 2011 to 2012. The 5 year and 10 year low PS price targets are overvalued by 21.0% and 7.3%, respectively.

Dividend Discount Model:

For the DDM I assumed that Caterpillar will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 6.34%. After that I assumed CAT can continue to raise dividends by 3.50% annually and used a discount rate of 8%. Based on this CAT is worth $47.67 meaning it's overvalued by 71.7%

PE Ratios:

CAT's trailing PE is 10.32 and it's forward PE is 7.49. The PE3 based on the average earnings for the last 3 years is 18.92. I prefer for the PE3 to be less than 15, which in this case means that Caterpillar is currently overvalued. Compared to it's industry, CAT seems to be undervalued versus the industry as a whole (13.46). All industry comparisons are on a TTM EPS basis.


Caterpillar's gross margin for FY 2010 and FY 2011 was 34.09% and 31.74% respectively. While I would prefer for it to be higher, 30% is still a solid number and it has been very stable since 2001. Their gross margin has average 31.16% since 2001 with a high of 34.09% and a low of 28.40%. Their net income margin for the same years were 6.34% and 8.19% respectively. I like the net income margin to be at least 10% and preferably rising. Caterpillar is lacking in this area, and it seems like they might be at the high end of their net income margin. Typically it has ranged around 4% in lean years and 9% in fat years. This is pretty typical for Caterpillar seeing as how it is a very cyclical business. The cash-to-debt ratio for the same years were 0.18 and 0.12. Their gross profit and net profit margins had typically been greater than the industry as a whole, but for FY 2011 it dipped to only 81% and 65% of the industry's standards.

Share Buyback:

Caterpillar's shares outstanding were doing great with steady decreases until 2008. Since then their shares outstanding have risen by a significant amount and they have retraced half of what they had bought back. As long as their shares outstanding remains relatively flat to decreasing that's a good sign since the money they earn and payout as dividends goes further with a smaller share base. I would monitor this since it could be an issue going forward.

A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.

Dividend Analysis:

Caterpillar is a dividend contender with 19 consecutive years of dividend increases. Their annual increase for the last 1, 3, 5 and 10 years has been 12.22%, 6.34%, 8.88% and 11.18%. Their payout ratio is looking good at 24.32% for FY 2011 and except for a 2009 hasn't had a year that is troubling. The average payout ratio since 2001 is 42.90% and has ranged from a low of 21.28% to a high of 117.48%. It could be a good sign that the payout ratio is on the low end since it opens the board up to return more cash to shareholders as dividends.

Their FCF was not looking good from 2001 through 2004 but since then has been steady as she goes. That is, until 2011. I haven't looked through the annual report for 2011 to see what the explanation is for it but I would definitely research that to find out why. They had averaged $3.74 positive FCF per share from 2005 to 2010 and then a negative $5.20 in 2011.

Return on Equity and Return on Capital Invested:

Caterpillar's ROE and ROCI had been in a uptrend through 2008, but 2009 brought a big cut and they still haven't returned back to pre-recession levels. If they can steadily improve these numbers that could be a good sign of things to come.

Revenue and Net Income:

Since the basis of dividend growth is revenue and net income growth I've added a new section to my stock analysis. Here you can see CAT's history of revenue and net income since 2001. Their revenue took a big hit from 2008 to 2009 but has been trending upwards since then and for 2011 was actually higher than the 2008 level. In 2011, Caterpillar hit a high in net income. Since 2001 their net income has been in an ebb and flow cycle with about 3 years of low then 3 years of high, which is typical for a cyclical industrial equipment maker.

Average Price and EPS:

Caterpillar's average share price has been following the growth in EPS relatively closely since 2001 except for in 2012. This is good news for investors as it could mean that a PE expansion could be coming. Currently CAT is way below it's typical PE range.


The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years, 10 years or 16 whichever is least. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target PE is 7.94. This corresponds to a entry price of $75.73, meaning that CAT is currently trading at a $6.11 premium to the forecast entry price. I think based of PE alone, the current price of $81.84 is a decent entry since it is trading on the lower end of it's normal PE.


The average of all the valuation models gives a fair value of $101.52 which means that Caterpillar is currently trading at a 19.4% discount to the average fair value. I've also calculated the fair value with the highest and lowest valuation methods thrown out. In this case, the DCF and DDM valuations are thrown out and the new average is $77.96. Caterpillar is trading at a 5.0% premium to this price.

All in all Caterpillar appears to be an okay investment at these prices, but more for total return than as a dividend/income stock. Unless dividend growth severely ramps up it's not a good value at these prices. At the $77.96 fair value price your yield would be 2.67% which would be a spot where I would be okay with starting a position from a dividend standpoint, but a great entry from a total return stand. Especially if you feel that the global economy will be moving forward sooner than it takes another step back.


  1. This analysis is a big help for those who are involve in industrial equipment just like me. Good thing you provide this.


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