How To Justify Caterpillar's $95 Share Price

| About: Caterpillar Inc. (CAT)

Summary

Shares have had an incredible run since early this year.

Dividend yield is still a good 3.25%.

The dividend yield should be rock solid. Let's take a look.

Earlier this year, I was a huge bull on Caterpillar (NYSE:CAT) as their shares dipped under $60 and the dividend yield exceeded 5%. It was an incredible buy, even for a cyclical company which seems to be a few years into their slowdown.

"The harder the party, the longer the hangover."

- Author unknown.

As Caterpillar derives a significant amount of its revenues from mining, an uptick in commodity prices and recovery in this space will be essential for a return to normalized profitability.

As the company is a long-standing mature company, let's take a look back to the past results and share prices which came from the 2009 decline. Here are the yearly high and low share prices for the stock along with the amount of shares outstanding and total earnings. Shares outstanding and total earnings are in millions. The 2016 numbers are estimates. All numbers are from the company's annual reports with the table being created by the author.

Share Price Shares Out. Price / Earnings EPS Total Ear.
High Low High Low
Year 2016 96.44 56.36 585.07 29.67 17.34 3.25 1901.48
Year 2015 92.40 63.00 582.32 20.00 13.64 4.62 2690.32
Year 2014 111.50 85.90 606.17 17.50 13.49 6.37 3861.30
Year 2013 99.70 79.50 637.82 17.22 13.73 5.79 3692.98
Year 2012 116.90 78.30 655.05 12.49 8.37 9.36 6131.27
Year 2011 116.60 67.50 647.53 14.93 8.64 7.81 5057.21
Year 2010 94.90 50.50 638.82 22.87 12.17 4.15 2651.10
Year 2009 61.30 21.70 624.72 42.87 15.17 1.43 893.35
Year 2008 86.00 32.00 601.53 15.06 5.60 5.71 3434.74
Year 2007 87.00 58.00 613.99 16.35 10.90 5.32 3266.43
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As of the end of the 3rd quarter in 2016, the EPS have totaled $2.26. The estimate for the 4th quarter EPS are $0.99 per share.

So back to the original idea: justifying the share price of $95.

Looking at the table above, I can justify a P/E ratio of 18 times.

$95 / 18 = earning per share of $5.28 to justify the current share price of $95. The estimate for this year and next is $3.25 EPS.

It seems based only on the P/E ratio, it is not possible to justify this. Let's move forward and look at the dividend yield.

Annual Dividend
Share Price Yield as a % EPS Payout Ratio %
High Low High Low
Year 2016 96.44 56.36 3.08 3.19 5.46 3.25 94.77
Year 2015 92.40 63.00 3.01 3.26 4.78 4.62 65.15
Year 2014 111.50 85.90 2.70 2.42 3.14 6.37 42.39
Year 2013 99.70 79.50 2.32 2.33 2.92 5.79 40.07
Year 2012 116.90 78.30 2.02 1.73 2.58 9.36 21.58
Year 2011 116.60 67.50 1.82 1.56 2.70 7.81 23.30
Year 2010 94.90 50.50 1.74 1.83 3.45 4.15 41.93
Year 2009 61.30 21.70 1.68 2.74 7.74 1.43 117.48
Year 2008 86.00 32.00 1.62 1.88 5.06 5.71 28.37
Year 2007 87.00 58.00 1.38 1.59 2.38 5.32 25.94
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It seems the dividend yield (even at a high share price) is a healthy 3.25%. Or, are investors duping themselves?

In reality, a dividend yield of 3.25% seems very good, but as the payout ratio gets closer to 100%, it may not be sustainable for too much longer. The reality is the company has only so much profit to go around and as time moves on, it will be essential to find money to re-invest into the business. It has to come from somewhere.

At the present time, the average dividend yield for 2016 has been approximately 4.3% while the cost of debt has been slightly above 3% (After tax). The company has done an excellent job repurchasing shares in the past, but will not be as nimble as profit has declined in the past few years.

As a bull, I would be very afraid of purchasing shares at these levels. It seems there is much more potential for a decline in value rather than an increase in value. Unless I am missing something, I cannot see any further upside from here unless a major recovery takes hold.

Currently, I own put options on this security and am neither long, nor short the stock. The disclaimer will show: short, as I own put options.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in CAT over the next 72 hours.

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