Should You Buy the Dow — Caterpillar

Today well look at Caterpillar (NYSE: CAT ), the 86-year-old machinery company.
Actually, Caterpillar offers a lot more than construction equipment, and its
even in the financial business. The Machinery Segment offers construction,
mining and forestry machinery. It also manufactures diesel-electric locomotives,
and it manufactures and services rail-related products and logistics services
for other companies. The Engines Segment provides diesel, heavy fuel and natural
gas reciprocating engines for Caterpillar machinery, electric power generation
systems, marine, petroleum, construction, industrial, agricultural and other
applications. It offers industrial turbines and turbine-related services for oil
and gas, and power generation applications. The Financial Products Segment
provides retail and wholesale financing alternatives for Caterpillar machinery
and engines, solar gas turbines and other equipment and marine vessels, as well
as offers loans and various forms of insurance to customers and dealers. It also
offers financing for vehicles, power generation facilities and marine vessels.
The key factor for Caterpillar is the overall economy. If the economy is humming
along, then things are being constructed. And if things are being constructed,
it probably means some of that construction equipment is being financed. If the
economy is tanking, the situation is reversed. Some of this is blunted because
America always farms, so the farming equipment side is somewhat protected.
Nevertheless, Caterpillar essentially is a cyclical business, so if you are
going to be in the stock, you better be in it for the long term. The good news
is that the economy is improving in the areas that Caterpillar services, so
things are looking up. This is reflected in stock analysts five-year outlook on
Caterpillar, which sees annualized earnings growth at 17.5%, but that includes a
61% earnings increase in 2011 and another 35% increase expected in FY 2012. That
suggests low or no growth after that. At a stock price of $85, on FY 2011
earnings of $6.68, the stock presently trades at a P/E of 13. CNH Global (NYSE:
CNH ) is the closest competitor at a P/E of 9, so there's a minor suggestion
that Caterpillar is overvalued, but not much. Caterpillar carries $10.7 billion
in cash, and $25.9 billion in debt at a blended interest rate of only 1.6%.
Trailing 12-month cash flow was $3.4 billion, so the debt service is no problem.
The company also had 3.9 times the amount of free cash flow necessary to pay its
2.2% dividend. So CAT appears to be on solid footing financially. Caterpillar
has had two insider purchases of about 3,000 shares in the past year. Thats not
a huge endorsement, but it is better than nothing. Conclusion Placing a 17 P/E
on Caterpillar, with projected 2015 earnings of $9.50 per share, gives us a
price target of $162. Add in reinvested dividends, and that suggests about a
110% total return. The trick is how will Caterpillar fair after these next two
years of mega-recovery off the recession lows? What happens if we fall into a
double-dip? Fortunately, I'd say that since the company trades at a 13 P/E
compared to 17.5 where it might be arguably valued, there's enough margin for
error to make it a buy. I believe Caterpillar is a buy for regular accounts. I
believe Caterpillar is a buy for retirement accounts. Lawrence Meyers does not
own shares of Caterpillar.