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Caterpillar Inc. (CAT): Is It Destined for Greatness?

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Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Caterpillar Inc. (NYSE:CAT) fit the bill? Let’s take a look at what its recent results tell us about its potential for future gains.

What we’re looking for

Caterpillar Inc. (NYSE:CAT)

The graphs you’re about to see tell Caterpillar Inc. (NYSE:CAT)’s story, and we’ll be grading the quality of that story in several ways:

1). Growth: Are profits, margins, and free cash flow all increasing?
2). Valuation: Is share price growing in line with earnings per share?
3). Opportunities: Is return on equity increasing while debt to equity declines?
4). Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you

Now, let’s take a look at Caterpillar Inc. (NYSE:CAT)’s key statistics:

CAT Total Return Price Chart

CAT Total Return Price data by YCharts

Passing Criteria 3-Year* Change Grade
Revenue growth > 30% 78.3% Pass
Improving profit margin 50.7% Pass
Free cash flow growth > Net income growth (3.9%) vs. 168.8% Fail
Improving EPS 158.8% Pass
Stock growth (+ 15%) < EPS growth 54.3% vs. 158.8% Pass

Source: YCharts. * Period begins at end of Q2 2010.

CAT Return on Equity Chart

CAT Return on Equity data by YCharts

Passing Criteria 3-Year* Change Grade
Improving return on equity 31.3% Pass
Declining debt to equity (29.3%) Pass
Dividend growth > 25% 36.4% Pass
Free cash flow payout ratio < 50% 47.6% Pass

Source: YCharts. * Period begins at end of Q2 2010.

How we got here, and where we’re going

Caterpillar Inc. (NYSE:CAT) puts together an extremely strong performance, earning eight out of nine possible passing grades. It missed out on a perfect score because of falling free cash flow, which has diverged from its net income over the past three years, and which threatens to undermine the health of its dividend payments. Will Caterpillar to able to move past this problem? Let’s dig a little deeper to find out.

Last month, Caterpillar Inc. (NYSE:CAT) disappointed investors by missing on both the top and bottom lines in its latest earnings report. The company’s revenue fell 16% year over year, and double-digit declines are never a good sign for a company widely viewed as a construction and industrial bellwether. Caterpillar’s resource industries, primarily devoted to mining, suffered a terrible 34% drop year over year as the global mining industry continues to suffer through brutal price declines across a range of earth-bound commodities.

Despite this weakness, Caterpillar recently launched an accelerated $1 billion capital-return plan that should boost shareholder confidence in the company’s core business activities. With signs of relative strength in the United States offering some breathing room, Caterpillar has decided to keep an eye on its international markets, especially its mining and construction segment, which now comprises 70% of its total revenues. Fool contributor Dan Caplinger notes that Caterpillar has managed to maintain $20.4 billion in order backlog in spite of its present weakness.

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