Long-Term Growth Makes Caterpillar Inc. (CAT) a Smart Buy

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The worldwide economic recovery appears to be encouraging; particularly, a couple of select sectors are demonstrating optimistic signs in fiscal year 2013. The industrial goods sector is one that is likely to entice investors as the worldwide economic recovery picks up. A stronger economy should help the industry to increase profits through improvements in sales volumes rather than expense cutting.

In this bright scenario, Caterpillar Inc. (NYSE:CAT) remains one of my favorite picks. And I really believe that the market is already discounting a lot of bad news on earnings (an earnings decline of as much as 40% this year appears to be embedded in the stock’s valuation), which makes it a buying opportunity for investors.

Caterpillar Inc. (NYSE:CAT)

Diversified business

Caterpillar Inc. (NYSE:CAT)’s business is actually broken down into four key segments: resource industries, construction industries, power systems, and financial products. The largest and most important segment for fiscal year 2012 pertained to resource industries as this section brought one-third of the company’s total annual revenue.

The rest of the segments are also not far off. This diversity with respect to types of business operations is very intelligent, as approximately similar amounts of exposure have been granted to resource, construction, and power systems, whereas the high-risk section of financial products has been limited to less than 5%.

The expansion approach adopted by Caterpillar resembles its business operations as the company is not solely dependent on any single growth driver. The company has paid great attention to strategic acquisitions along with its adaptation of new technology through increasing R&D expenditures. The company’s overall capital expenditures have projected a compound growth rate of 30% since fiscal year 2009.

How competitors are faring

CAT JOY DE ITW Average Industry
Market Cap (billions) 56.4 5.75 33.8 31.6 31.9 32.5
Revenue (billions)
63.1 5.5 37.7 17.6 31 34.8
P/E 12.3 7.9 10.7 11.9 10.5 25.8
Dividend Yield %
2.4 1.3 2.2 2.2 2 1.55
Profit Margin %
7.9 13.3 8.5 15.6 11.3 7.1

When compared to its competitors, which include Joy Global Inc. (NYSE:JOY), Deere & Company (NYSE:DE), and Illinois Tool Works Inc. (NYSE:ITW), the table above clearly shows that Caterpillar Inc. (NYSE:CAT) is the largest company in the industry in terms of both revenue and market cap. The P/E ratio is considerably below that of the industry, implying possible undervaluation of the company. The company’s profit margin is lower than its close competitors as Caterpillar seeks to maintain its volume advantage, which generates the large revenue. Despite this approach, the profit margin of the company is greater than the industry average.

For Joy Global Inc. (NYSE:JOY), given the existing levels of backlog of more than $2.2 billion and still enviable global aftermarket demand, the company has relatively good visibility in fiscal year 2013. This gives me assurance that any major drop in the stock price is very unlikely. Joy Global trades at trailing P/E of only 7.9, has a 15% long-term earnings growth rate, and a decent 1.3% dividend yield. The current payout ratio stands at just 10%, leaving significant room for dividend hikes.

More than 65% of Joy Global Inc. (NYSE:JOY)’s revenue comes from coal-related projects as customers involved in coal mining provide the commodity for steel production. Therefore, any increase in steel-product-related activity is likely to improve demand for the Joy Global’s products.

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