Does Caterpillar Belong in Your Portfolio?

With shares of Caterpillar (NYSE:CAT) trading around $108, is CAT an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Caterpillar is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. It operates in two segments: Machinery and Power Systems, and Financial Products. Infrastructure investment is increasing around the world — in particular, in developing countries. A global supplier of industrial equipment, like Caterpillar, is poised to see rising profits from this trend. As long as countries continue to grow and develop, Caterpillar will provide the tools essential to create this progress.

Caterpillar said it will close two production plants and a distribution facility in Illinois and shift the work to a plant in Michigan. The move is a cost-cutting measure, according to the company, and will mean the loss of about 170 jobs. The three plants — two in Sterling and one in Dixon — belong to Anchor Coupling, a subsidiary of Caterpillar. Anchor Coupling makes hydraulic hose assemblies for Caterpillar machines. The transition is expected to be completed in first-quarter 2015. Caterpillar said employees who are displaced will be offered severance packages from the company.

T = Technicals on the Stock Chart Are Strong

Caterpillar stock has been surging higher over the past couple of quarters. The stock is currently trading near all-time highs and looks set to continue. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Caterpillar is trading above its rising key averages, which signals neutral to bullish price action in the near-term.

Source: Thinkorswim

Taking a look at the implied volatility (red) and implied volatility skew levels of Caterpillar options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Caterpillar options

19.57%

90%

88%

What does this mean? This means that investors or traders are buying a very significant amount of call and put options contracts, as compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

July Options

Flat

Average

August Options

Flat

Average

As of Monday, there is an average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a very significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

E = Earnings Are Increasing Quarter-Over-Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. Also, the last four quarterly earnings announcement reactions help gauge investor sentiment on Caterpillar’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Caterpillar look like and more importantly, how did the markets like these numbers?

2014 Q1

2013 Q4

2013 Q3

2013 Q2

Earnings Growth (Y-O-Y)

9.92%

48.13%

-42.91%

-44.73%

Revenue Growth (Y-O-Y)

0.23%

4.71%

-15.83%

-17.34%

Earnings Reaction

1.83%

5.94%

-2.43%

2.83%

Caterpillar has seen rising earnings and revenue figures over the last four quarters. From these numbers, the markets have been pleased with Caterpillar’s recent earnings announcements.

P = Excellent Relative Performance Versus Peers and Sector

How has Caterpillar stock done relative to its peers – Deere (NYSE:DE), General Electric (NYSE:GE), and Cummins (NYSE:CMI) — and sector?

Caterpillar

Deere

General Electric

Cummins

Sector

Year-to-Date Return

19.70%

2.01%

-2.19%

13.34%

9.21%

Caterpillar has been a relative performance leader, year-to-date.

Conclusion

Caterpillar is a provider of construction and related industrial products and services during a time when countries around the world are seeing expansion. The company said it will close two production plants and a distribution facility in Illinois and shift the work to a plant in Michigan. The stock has been surging higher and is currently trading near all-time highs. Over the last four quarters, earnings and revenues have been on the rise, which has left investors pleased. Relative to its peers and sector, Caterpillar has been a relative year-to-date performance leader. Look for Caterpillar to OUTPERFORM.

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

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