Is Caterpillar's Sell-Off Over?

| About: Caterpillar Inc. (CAT)

Caterpillar (NYSE:CAT) is one of the most solid companies to own in the stock market. The company took great advantage of the high demand for its machinery due to rallying material prices and increased construction activity in developing nations. The company has been posting impressive growth lately, however it's been in sell-off mode for the last 3 months due to concerns about slowing economy in the emerging markets.

After hitting a high price of $115 in February, Caterpillar's stock price started to go down. By the end of March, the stock was trading for $106, by the end of April, it was trading for $102 and last Thursday, it traded for $87.80. Last Thursday's closing price gave the stock a P/E ratio of 11. At that point, investors decided that the company's stock price had plunged more than enough. Since last Thursday, the stock has been up by about 5% and there is plenty of more room for the stock to go up.

Caterpillar seems to find strong support when the price goes below $88. Last time Caterpillar traded for a price below $88 was in December and this was followed by a strong rally, carrying the company's stock price all the way up to $116. If the market allows, we may be able to see a similar rally in the next couple months.

In the developed nations, there isn't as much construction activity as in the developing nations, however, there is still a high need for new construction equipment as average age of construction equipment in the western countries is pretty high. In the next few years as the economy starts taking off again, many construction companies will want to replace their old equipment with new equipment. This will offset the slowing demand in the developing nations and fuel the company's growth for another few years.

Currently Caterpillar's biggest concern is about meeting its high demand, rather than not having enough demand. In the last quarterly earnings announcement, the company announced that it would ramp up production and increase number of its plants in order to meet the high demand.

Another positive note about Caterpillar is that the company's purchase of Bucyrus has been paying off really nicely. After the two companies are completely integrated, the company's operating costs will drop and its margins will improve further. I see nothing but good things for Caterpillar in the short to medium term (1 to 5 years).

The company is expected to earn $9.75 this year, which translates into a forward P/E ratio of 9.4. This is a very healthy number for a growth company like Caterpillar. I believe that Caterpillar can easily carry a P/E ratio of 15, which gives it an upside of more than 50%. Sooner or later investors will realize the true value of this great company.

Disclosure: I am long CAT.