Caterpillar (CAT -0.18%) stock dropped 9% since its most recent earnings report as the world's largest construction equipment manufacturer faces a dwindling backlog amid higher interest rates. Anytime a stock for an industry leader drops due to macroeconomic challenges, investors should determine whether there is a potential buying opportunity.
So let's examine Caterpillar's latest financial snapshot, its valuation, and management's capital allocation to determine whether investors should buy the discounted stock or stay away.
Caterpillar's first-quarter sales declined year over year
Starting with the bad, Caterpillar generated $15.8 billion in sales and revenue for Q1 2024, a slight year-over-year decrease from $15.9 billion. Management blamed lower sales volume for the decline in sales, most notably in Europe, the Middle East and Africa, and the Asia-Pacific region.
Despite the lower sales volume, Caterpillar flexed its power as the industry leader with favorable price hikes to maintain its top line. The price realization also translated to a 10-year quarterly high operating profit margin, which stood at 22.2% in Q1 2024, representing a 1.1% year-over-year increase.
Looking ahead, Caterpillar's order backlog stood at $27.9 billion at the end of the most recent quarter, a decrease of $2.5 billion compared to a year ago. Despite the dwindling backlog, management expects 2024 sales and revenue to be "broadly similar to the record 2023 level."
Additionally, Caterpillar continues to benefit from the largely untapped $1 trillion of federal spending from the 2021 Infrastructure Investment and Jobs Act in the United States. CEO Jim Umpleby underscored this point in the company's most recent earnings call: "Nonresidential construction is underpinned by those government infrastructure projects, which again is a very positive thing for us."
A focus on returning capital to shareholders
Caterpillar's commitment to its shareholders shines through its capital allocation strategy, particularly with its dividend track record. The company holds an impressive 91 consecutive-year streak of dividends, raising it for each of the last 30 years. Currently, Caterpillar offers a quarterly dividend of $1.30 per share, equating to an annual yield of approximately 1.6%.
With any dividend-paying stock, it's important to understand its payout ratio -- a metric illustrating how much of the company's earnings are paid out as dividends. Generally, any stock with a payout ratio of 75% or above is a cause for concern, as it could pose a risk of a dividend cut or freeze. Considering Caterpillar's payout ratio stands at 23%, investors can reasonably expect management to continue raising the dividend for the foreseeable future.
Image source: Getty Images.
Next, Caterpillar management frequently repurchases its stock, which increases the ownership stake of existing shareholders. Management has stated its intentions to continually deploy "substantially all" of its machinery, energy, and transportation free cash flow -- $1.3 billion in Q1 2024 -- on dividends and share repurchases. Management was even more aggressive in the first quarter, deploying $4.5 billion on share repurchases, bringing its basic outstanding share count down to 494 million, a 2.1% decrease from the previous quarter and a 4.3% year-over-year decrease.
Given management's public intentions and the fact that the company still has approximately $3.3 billion remaining on its current share repurchase program, investors will likely see their ownership stakes increase. Additionally, the effect of the share repurchases is showing up in the company's adjusted earnings-per-share (EPS), which was a record high of $5.75 per share in its most recent quarter despite the company's net income of roughly $2.9 billion being 2.3% off its all-time high.
Caterpillar stock looks cheap
No matter how great a business may be, overpaying can hinder future returns. That's why assessing a stock's valuation before buying it is essential. For mature companies like Caterpillar, you can use the price-to-earnings (P/E) ratio to compare competitors and historical averages and help determine a fair price for a stock.
As of this writing, Caterpillar trades at a P/E ratio of 15, which is higher than its smaller quasi-competitor Deere & Company's 11.3. One reason could be that Caterpillar's balance sheet is in better shape, with its net debt (total debt minus cash and cash equivalents) at $32.9 billion compared to John Deee's $57.3 billion. When you compare Caterpillar's current P/E ratio to its five-year average of 19.1, the stock appears to be on sale.
CAT PE Ratio data by YCharts
Is Caterpillar stock worth adding to your portfolio?
Caterpillar's dominance in the construction business is unlikely to be disrupted anytime soon. While the industry will always be cyclical, as the market leader, it should continue to benefit from the windfall of aging infrastructure and demand for new housing, particularly in North America.
While caution is warranted due to the possibility of softened demand amid elevated interest rates, Caterpillar's discounted stock valuation makes it an attractive addition to portfolios, particularly for those seeking dividends.
