The good news about the economic recovery last week has put hopes in many investors to look at some of the downtrodden companies hit hard by the global economic times like Caterpillar (CAT). It appears that as the economic news gets better so would the price of the stock because construction and building would go up. Even though this sounds like a logical idea, let's take a look at how an investor should approach stocks like Caterpillar and others in its industry.
Caterpillar- Worth a Look?
With the good news we had last week it looks like Caterpillar may be set to take back some value as the economic recovery starts to pick up. The stock has been on a roller coaster as of late. It rose to about $100 a share in February while it rested 20% below that in the fall of 2012. Presently, it's hovering just under $87 a share. From a value investor's standpoint, the stock looks pretty good, trading at 8.5 times net debt capitalization while historically it averaged 11.2 times. At these levels, the shares are quite enticing and considering the company has made good moves, cutting costs as well as inventory reduction, all we need is the economy to continue to move forward and the stock will also.
Even though I just mentioned the potential for buying Caterpillar, an investor needs to make sure that the logic behind a drop in price of a stock like that the company is sound. As an example, another machinery company, "Titan Machinery" (TITN), dropped in price from $32 a share to $22 after reporting its earnings. It looks like a good buy because of a huge dip-but is it? When a company comes out with poor earnings and its future guidance isn't much better there are a couple of things that can happen to an investor. The stock could continue to move down or could remain sideways for quite a while. How long are you willing to wait for the stock to be profitable again? It is not uncommon for a stock that plummets like Titan to start moving up in value before it goes down again because a number of investors buy into the dip believing it's going to recover? We have similar companies in Titan Machinery and Caterpillar. Titan has missed analyst expectations three times in a row now and since the businesses are so close, should an investor take a chance and invest in one of these low-priced stocks right now? I believe it depends upon and investor's philosophy of waiting - how long are you willing to wait until it becomes profitable again?
Apparently even some analysts are willing to take that risk as Longbow Research recently upgraded Caterpillar to a "buy." J.P. Morgan feels the same way as they have given the company an "overweight" rating, so not everybody is bearish on the stock.
It is no secret that in the last three months Caterpillar has dropped in value by 20%. It appears to have found a support level about $80.16 a share and has been moving up since the last week of April, but the "bounce" seems quite steep and I would not say the stock has turned the corner yet. It is reacting to the good news in the economy. If the economic news gets bad it seems the stock would turn down again. This recent bounce touched the upper Bollinger band and I am also observing bullish territory in the RSI indicator. The MACD indicator which measures the trend plus momentum is still in bearish territory, so I would not say the stock has made an about face yet. Simple observations point to a low in the bearish trend but not a turn yet.
As an investor, I must ascertain the risk I am willing to take in these companies right now. Am I willing to risk the bearish trend in the stock continuing on before it turns around and starts to make a profit? How long am I willing to wait before it turns profitable if I invest right now? These are important questions an investor needs to answer before investing in these types of companies. There is no guarantee that they will continue in a bullish pattern. This could just be a little bounce before it continues to move down. Keep these potential moves in mind before you invest in the stock.