CAT Leading The Bounce

By Gregory S. Davis | October 09, 2008 AAA



Before the Federal Reserve announced it would reduce the federal funds rate on October 8, the DJIA was moving upward by 10:00am led by upswings in American Express (NYSE:AXP) up 7.01%, Caterpillar (NYSE:CAT) up 4.30%, JP Morgan (NYSE:JPM) up 7.40% and Intel (NYSE:INTC) up 4.56%.

A closer look at Caterpillar tells investors that, although fundamentals may offer little support toward valuing a stock during these volatile times, demand from home and abroad could be the substitute investors use to make a judgment call.

Revenue Offsetting Rising Costs
Caterpillar will be releasing its third-quarter earnings on October 21. Taking a look back over the first half of the year, Caterpillar managed to increase revenue nearly 19% from the same period a year ago to $25.4 billion. Investors should note that Caterpillar's increase in revenue was enough to offset an increase in its material costs. The offsetting revenue allowed Caterpillar to deliver an operating profit margin north of 11%. Although Caterpillar revenue increased in each of its 11 business segments, which include everything from Infrastructure Development to Marine & Petroleum Power, the largest revenue gain came from sales of Machinery & Engines.

Growing Globally
Caterpillar announced expansion plans in June for the U.S., China and India in order to keep pace with demand for its earth moving equipment. At the end of the second-quarter, Caterpillar reported being on pace to deliver profits in the neighborhood of $6 per share. The additional capacity is also being done in preparation for the eventual upswing in the U.S. market.

Although foreign securities have posted huge losses, like those tracked by the iShares MSCI Emerging Market Index ETF (AMEX:EEM) that is down 42.64% since the beginning of the year, the emerging markets tracked by the fund are leading the revenues Caterpillar is generating. In the second quarter, Caterpillar generated higher revenue than in the previous year due to demand from oil producing countries in Africa and the Middle East, increased construction and mining activity in China along with increases in iron ore and coal mining in Latin America.

Competition
Value investors would be happy with Caterpillar's low PEG ratio of 0.67 and its equally low price-to-sales ratio of 0.59. The PEG below 1 suggests strong earnings growth over the next five years, while the low P/S ratio suggests investors are paying 59 cents for each $1 of revenue generated by Caterpillar. Competitors with equally low PEG ratios include Komatsu LTD with 0.45 and CNH Global NV (AMEX:CNH) with 0.44. (For added insight, read PEG Ratio Nails Down Value Stocks.)

Final Thoughts
When fundamentals can't be trusted, stick to the basics of supply and demand when it comes to choosing investments for your portfolio. The Dow Jones Industrial Average may continue to sink, but companies best prepared to gain from meeting the demand of emerging markets will earn future market leadership.

For related reading on Fed intervention, read How Much Influence Does The Fed Have?

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