Here’s today’s menu:

• Introduction

• Stock information

• Company background

• Financial performance

• Stock price performance

• Valuations: relative and discounted cash flow

Introduction

I never thought I would find an Extraordinary Company in the machinery sector. In the modern economy, one tends to find higher return companies in these sectors:

• pharmaceuticals

• software

• media

• household & personal products

But I ran the numbers on Caterpillar and was very surprised to find that it is a fabulous company.

Let’s take a look.

Stock information

Company background

The Caterpillar Tractor Co. was founded 1925 but it was reorganised as Caterpillar Inc in 1986. Caterpillar manufactures:

• construction & mining equipment,

• off-highway diesel and natural gas engines,

• industrial gas turbines, and

• diesel-electric locomotives.

Caterpillar also provides financing services. The company has approximately 113 000 employees worldwide.

Revenue is split around the world as follows:

• North America 52% 

• Europe, Africa, Middle East 20% 

• Asia 18% 

• Latin America 10%

Financial performance

Caterpillar has a healthy and growing return on capital employed (ROCE), which has been averaging 17.1% over the past five years. As a rule of thumb, ROCE of 15% is very good. This has been a driver of the company’s superb performance in recent years.

Traditionally, high quality companies are thought to be asset light (i.e. they don’t have lots of fixed assets) and they have high profit margins. Caterpillar bucks that trend. You can see that if we compare Caterpillar’s stats to the average S&P500 company.

According to this table, Caterpillar looks pretty average. But look at the growth in free cash flow in the first table. Last year, it grew 99% and it had good growth in recent years.

Management has been reinvesting part of that cash flow in the business at good rates of return. Hey Presto! The company is growing and the stock price is responding accordingly.

Stock price performance

The graph below is the 10-year stock price growth chart (i.e. it shows the growth, not the price). Here are the returns over time:

• 1-year: 54.4%

• 3-year: 28.1% per annum

• 5-year: 27.2% per annum

• 10-year: 18.3% per annum

Over the past 10 years, Caterpillar had a total return of 18.3%. That is superb performance for any company, let alone a heavy machinery company.

By comparison:

• The Nasdaq 100 has grown at 19% per annum for 10 years.

• The S&P 500 has grown at 14% per annum for 10 years.

• The MSCI World Index has grown at 11% per annum for 10 years.

Caterpillar has outperformed the S&P500, the MSCI World Index and has almost equalled the Nasdaq 100. That is no mean feat, since the Nasdaq 100 contains tech companies, including the some of the highest return companies in the world.

Relative valuation

In terms of valuation, Caterpillar is trading at a price-to-earnings (P/E) of 17.9. This is below its 10-year average P/E of 25.7. The price-to-free cash flow ratio is 19 vs. 20.8 for the 10-year average.

On a relative basis, Caterpillar is getting cheaper because earnings and cash flow have been growing faster than the share price.

Discounted cash flow valuation

Caterpillar is selling at $392 per share which is above our moderate valuation of $326 per share. That means the company is selling at a premium of 20% to our moderate valuation (i.e. the margin of safety is negative).

Conclusion

Who knew that a heavy machinery manufacturer could be such a fabulous performer?

Caterpillar has been delivering good operational performance and the share price has followed. That is what we want to see in a good company.

Caterpillar is interesting and I think it is a company worth understanding better. Perhaps if it ticks our boxes, it might get added to our Extraordinary Company Investable Universe in future.

I would like to hear what you’re up to.

DM me on social media or email me.