Against my better judgment, which is never a good way to start out a long argument, I'm saying hold your nose and buy Caterpillar (CAT). Bear with me here, because there's an important point to be made regarding companies and stocks. This stock has already gained the favor of value seeking capital, as is evident by its recent price action, and is poised to move higher on more Federal Reserve fueled fervor and a sector shift into cyclical stocks that seems to be underway.
I say "against my better judgment" because of my economic and geopolitical view for the year ahead, which is not favorable. My economic contention has been well documented in my recent work on the economy (see more). However, oftentimes the economic environment and corporate operating outlook of a company do not align perfectly with a stock's performance. This is sometimes the reason why on occasion a good company does not make a good stock and vice versa. Remembering this wisdom, and while noticing the price action of cyclical names over recent days at the cost of safe haven ideas, I've been forced to bite the bullet and alter my sector strategy.
Look at the comparison of the safe haven Healthcare Select Sector SPDR and Consumer Staples Select Sector SPDR (XLP) versus the risky cyclical groups represented by the Industrial Select Sector SPDR (XLI) and the Technology Select Sector SPDR (XLK).
Healthcare Select Sector SPDR
Consumer Staples Select Sector SPDR
Industrial Select Sector SPDR
Technology Select Sector SPDR
In my position as a financial journalist/analyst, I cannot ignore what other investors are doing and how their activity is affecting stocks, no matter the corporate or economic outlook. That activity or flow of funds is fueling the sort of action I'm talking about here. As a result, the current period looks favorable for cyclical stocks like Caterpillar, especially those with attractive valuations and in the sweet spot of a sector shift that appears to be underway. It may all be the result of capital inflows into equity funds and not based on solid economic reasoning, but it is dictating stock market performance just the same (for now). Because of the variance between my economic view and stock view, this is a short-term recommendation, for roughly the next two months, or until the next earnings report, ahead of which I hope to review the idea again for you.
Caterpillar was one of the dogs of the Dow in Q1, as seen in the chart above. There is good reason for that, as the company's last earnings report was full of concern and contraction of business efforts. Analyst consensus earnings estimates are severely on the downslide, with the last 90 days seeing significant reduction.
Full Year 2013
EPS Estimate Today
EPS Est. 90 Days Ago
While the performance of the stock was initially dictated by the company's results and outlook, it has since shifted, driven by capital demand and valuation.
Total Return Last 90 Days
Total Return Since February High
Total Return Since April Low
Total Return Q2
Total Return Q1
High and low prices used were intraday prices not closing prices
Given CAT's valuation, with a P/E of about 12.7X the analysts' consensus EPS estimate of $6.94 for 2013 and 10.9X the consensus number of $8.05 for 2014, the stock does not look expensive. Between those two years is 16% EPS growth, and analysts project a five-year average annual growth pace of 14%. If we incorporate CAT's dividend yield of 2.4% into that growth to get total return, we find an attractive stock. The P/E-to-growth pace on the 2013 EPS estimate and 5-year growth outlook, incorporating the 2.4% dividend yield into that denominator (16.4%), would be 0.77. So, if you can close your eyes and ignore the economy, you can hold your nose and buy CAT here. However, you had better pray the economic outlook does not degenerate further, and also reconsider the shares' valuation in a month or two, ahead of what could be a difficult earnings report for this quarter.