Bombarded with news everyday, the price of a stock can move up or down with exaggeration. For a long-term investor, it helps to ignore the noise and buy a stock after it has a substantial pullback. This is especially so for a cyclical company. It's common that when there's news of soft demand from China, Caterpillar (CAT) drops on that day. That's why it's so important to buy Caterpillar with a significant margin of safety. How much is significant you ask? Since Caterpillar has a higher beta of 1.9, it is more volatile than the general market. So, is a 25% pullback from its 52-week high enough as the margin of safety?
Morningstar's fair value estimation of Caterpillar is $98. As of the close of April 19, 2013, its price is $80.43, which is ~18% below that estimation. F.A.S.T. Graph's 15 year graph shows that according to an estimation of EPS of 7.66 for the end of 2013, Caterpillar is estimated to have a fair value of ~$114 by that time. This is almost a 30% discount.
Caterpillar is also a proud dividend contender, having increased dividends for 19 years. Its 5 year average dividend growth rate is 14.2%, and it currently yields 2.59%.
The heavy equipment giant has a solid balance sheet, scoring an S&P rating of "A." Its debt-to-equity ratio has stabilized from a high of 3.54 in 2009 to its current level of 2.28. It's impressive that its EPS increased 9 out of the last 10 years. Similarly, its book value per share has increased in a general uptrend from 8.84 in 2003 to 26.76 in 2012. Looking at its free cash flow, it was positive for 9 of the last 10 years.
Caterpillar's Rock Solid Position
1. Emerging Markets
Caterpillar's strategic purchase of Shandong SEM Machinery Co., Ltd. (or "SEM") in 2005 has expanded its product line. "Beyond product and manufacturing expansions, SEM also has expanded its sales and service support. SEM dealers are now in 33 countries to provide sales, parts and basic service support capabilities. In 2013, SEM is adding dedicated parts distribution centers outside China."1
Caterpillar Vice President Tom Bluth says, "It gives us the opportunity to position ourselves in China and other growth markets, but more importantly, it enables us to serve customers early in their industry experience and move them over time toward the Cat brand value proposition, establishing a relationship that will keep them with Caterpillar for the long term."
2. Customer-Driven Technology
Caterpillar is differentiating its business by developing customer-driven technology to allow customers to access real-time data to optimize productivity.
3. Mining Equipment
"Since July 2011, Caterpillar has added more than 100 products to its mining portfolio, many of which were showcased at the MINExpo exhibit."2
4. Global Parts Distribution Network
Caterpillar makes sure its customers have the right part, at the right place, at the right time. "Caterpillar ships more than 158 million parts orders a year. That translates into 400,000-plus orders per day, 18,000-plus orders per hour, 300-plus orders per minute of every day of every year."3
With Caterpillar about 5% from its 52-week low and 25% from its 52-week high, buying it at this level will serve as a portfolio booster for a capital gain of north of 20% if an investor expects it to get back to the high 90s in a year, while you get to wait with a 2.5% yield.