The Goldman Sell Order On Caterpillar Suggests A Spread Trade

| About: Caterpillar Inc. (CAT)

Summary

Goldman thinks we're entering a commodity depression, and Caterpillar should be sold.

If the company is right the stock should fall into the range of General Motors.

Spread traders might play the two against each other to profit with less risk.

The Caterpillar (NYSE:CAT) "sell" command from Goldman Sachs (NYSE:GS) is based on the assumption that a "commodity deflation cycle" has just begun and will continue for years.

If you want to join the rush, maybe even playing it through options, you are taking on some risk. Governments could create demand in many ways, which would turn around those prices on a dime and put your investment at risk.

So here's an idea. While you're selling CAT, buy General Motors (NYSE:GM).

Caterpillar drew more favor from investors than GM during the early part of the recovery. Some of that was political, people resenting the bailout of the auto-maker. Some of it was rational, because Caterpillar participated fully in the commodity boom that preceded the recent bust. But even after it proved itself with some big quarters, even instituting a dividend, GM has continued to move sideways.

Right now, GM is paying a fat 36 cent/share dividend, and yielding 4.92%. An outright buy on GM, for a dividend investor, is not a bad call. You're not risking much going there, and the auto recovery should have some ways to go yet. The average car on the road is 11.5 years old, a record.

You are not taking big risks getting into GM here. The market cap is $45 billion, and quarterly sales are up to $38 billion. You don't see those kinds of ratios at healthy companies. The only similar case that comes immediately to mind if JC Penney (NYSE:JCP) - a market cap of $2.1 billion with quarterly sales of $2.9 billion. But Penney's doesn't make money. GM turned those $38 billion in sales into $1.36 billion of profit last summer.

Caterpillar, meanwhile, should report revenues of about $48 billion for the year on its $34 billion market cap. The company reports Thursday, with analysts expecting earnings of 72 cents per share on revenues of $11.42 billion. Maybe it misses those numbers, and maybe it goes down further.

That's a reasonable speculation, but wouldn't you like to have some protection in case you're wrong? Setting GM against CAT is one way to do that. Simply set up a spread trade - GM on the buy side, CAT on the sell. If there's a surprise on one side or the other, take it off. But if Goldman is right, and CAT has a long way to go down - perhaps down to the Price/Sales rate of about 30 cents GM now experiences - you will be doing well.

Just a thought. This is not the kind of thing I like to do with my own money, which is in a retirement account. But for professional traders, or smaller traders who are interested in making big profits through spreads, this is an idea worth investigation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.