Caterpillar Inc. (CAT) shares delivered strong returns of 37.6 percent over the 12-month period that ended in May 2017, but the stock still has not reached the previous highs around $110 seen in 2014, 2012 and 2011. Caterpillar stock suffered in 2015 as a sluggish global economy and depressed commodity prices affected the company's underlying fundamentals. Such a rapid recovery in stock prices would therefore suggest a rebound for Caterpillar's financials, so investors should analyze recent results to understand if the surging prices were the result of improving fundamentals or rising valuation.

CAT Efficiency Ratios

Caterpillar has endured a sustained downward trend in revenue, but it is showing signs of a turnaround. Demand dried up in end markets such as mining, international construction and energy as global macroeconomic conditions deteriorated and commodity prices fell. This threatened volumes as well as pricing for Caterpillar, weighing on the top line. Cyclical downturns are common for machinery suppliers, but the breadth of affected industries was particularly challenging for Caterpillar. Revenue was $38.5 billion in 2016, representing a 41 percent decline from 2012's total. However, the company reported 4 percent sales growth in the first quarter of 2017, and management is forecasting a flat top line for the full year, indicating a potential turnaround of cyclical struggles. (See also: Caterpillar Sales May Rise 20% on Boost From Trump Policies: Barron's.)

CAT Gross Margin

Gross margin has fluctuated, but it has not clearly trended negatively, which indicates some resistance to pricing pressure. The company managed 26.5 percent gross margin for the full year of 2016, falling near the lower end of the trailing-ten-year range of 25.2 percent to 28.7 percent. Gross margin improved 331 basis points in the first quarter of 2017 to 31.2 percent, indicating better conditions and successful cost restructuring efforts. Despite these improvements, the company still trails its peer group average in terms of gross margin. (See also: Caterpillar Headed Into 2017 Cross-Currents.)

CAT Margins

CAT Profitability

Caterpillar has experienced falling operating and net margins. Operating margin was 12 percent in 2012 and has since fallen to near 1 percent, having contracted by nearly a full percentage point year over year in the first quarter of 2017. Operating leverage was one important driver, as revenues fell and overhead did not change similarly. Selling, general and administrative expenses rose in 2016, and Caterpillar has also incurred non-recurring restructuring expenses. Free cash flow has suffered in recent years, but strong results and restructuring in late 2016 and early 2017 have helped restore cash flows to levels rarely exceeded in the past decade. (See also: Caterpillar: 6 Things You May Not Know.)

CAT Efficiency Ratios

CAT Operations vs. Peers

Caterpillar has seen its efficiency ratios slowly decline amid the recent struggles. Inventory turns have been mostly stable, but the overall trend over the past decade has been negative. At 2.98, the current value sits below the trailing-ten-year average of 3.38. Asset turnover sits at the lowest level of the past decade at 0.5, having previously been as high as 0.83. While the company is not currently meeting its own efficiency standards, it only moderately trails its peer group average of 0.58. (See also: How Is Asset Turnover Calculated?)

CAT Financial Health

Caterpillar's basic financial health metrics do not reveal any extreme risks, but they do warrant investor attention. The company's financial leverage is somewhat high, but this is common among the large companies in its industry. At 5.7, Caterpillar's equity multiplier is equal to the trailing-decade median for that line. This metric is slightly higher than those of its closest peers, which have a median value of 5.2. Notably, Caterpillar's American peers have much higher leverage, and its Japanese peers carry relatively lower debt. Caterpillar has adequate liquidity. Its current ratio is below the peer average, but it is still healthy at 1.29. The quick ratio looks safe at 0.89. (See also: Liquidity Measurement Ratios.)

CAT Valuation Table

Caterpillar's valuation reveals mixed results, so it could appear very different for various groups of investors. The company is expensive relative to book value, trailing free cash flow and on an enterprise-value-to-EBITDA basis. However, its forward P/E ratio is right in line with those of its peers, which is attractive given its superior growth outlook among analysts. This edge is demonstrated by a high PEG ratio. Caterpillar stock also pays a dividend yield of 3.1 percent, which is exceptionally high relative to peers. This could be very attractive for income investors looking for diversified, fundamental economic exposure through blue-chips. The suitability of Caterpillar stock in any portfolio ultimately depends on investor goals and risk tolerance. Compelling bull and bear cases could be made based on current fundamentals and valuation, depending on investor outlook and needs. (See also: Caterpillar Legal Woes Could Hurt Outlook.)

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