Despite A 7% Fall This Week Caterpillar Stock May Have More Downside

[Updated: 6/11/2021] CAT Stock Decline

The stock price of Caterpillar (NYSE: CAT) has seen a 7.4% drop over the last five trading days. While there was no major announcement from the company, CAT stock has been on a rise, with a 2x rally over the last one year, significantly outperforming the broader markets with the S&P500 up just 32%. This can be attributed to upbeat results over the recent quarters, improved demand outlook, and an expected rebound in the economy sooner than earlier anticipated. However, last month, we discussed why CAT stock looks overvalued at levels of around $240, given that most of the positives appeared to be priced in.

Now that CAT stock has fallen 7.4% in just five days, will it resume its downward trajectory over the coming weeks, or is a rise in the stock imminent? Going by the historical performance of CAT stock, it appears that the stock will rebound in the near term. Using the recent trend (7.4% fall in a week) and ten years of historical stock data, the Trefis AI engine finds that CAT stock will likely move by 3% over the next one month (twenty-one trading days). 

According to the Trefis Machine Learning Engine, which identifies trends in a company’s stock price using historical stock data, returns for CAT stock average around 3.1% in the next one-month (twenty-one trading days) period after experiencing a 5% fall in a week (five trading days), marking a 1.2% excess return compared to the S&P500. While these trends are based on the stock’s historical performance, going by our Caterpillar Valuation of $219, we believe that there may be some more downside to CAT stock. 

But how would these numbers change if you are interested in holding CAT stock for a shorter or a longer time period? You can test the answer and many other combinations on the Trefis Machine Learning Engine to test Caterpillar stock chances of a rise after a fall. You can test the chance of recovery over different time intervals of a quarter, month, or even just one day!

Some Fun Scenarios, FAQs & Making Sense of Caterpillar Stock Movements:

Question 1: Is the average return for Caterpillar stock higher after a drop?

Answer: Consider two situations,

Case 1: Caterpillar stock drops by -5% or more in a week

Case 2: Caterpillar stock rises by 5% or more in a week

Is the average return for Caterpillar stock higher over the subsequent month after Case 1 or Case 2?

CAT stock fares better after Case 1, with an average return of 3.1% over the next month (21 trading days) under Case 1 (where the stock has just suffered a 5% loss over the previous week), versus, an average return of 0.6% for Case 2.

Try the Trefis machine learning engine above to see for yourself how Caterpillar stock is likely to behave after any specific gain or loss over a period.

Question 2: Does patience pay?

Answer: If you buy and hold Caterpillar stock, the expectation is over time the near-term fluctuations will cancel out, and the long-term positive trend will favor you – at least if the company is otherwise strong.

Overall, according to data and Trefis machine learning engine’s calculations, patience absolutely pays for most stocks!

You can try the engine to see what this table looks like for Caterpillar after a larger loss over the last week, month, or quarter.

Question 3: What about the average return after a rise if you wait for a while?

Answer: The average return after a rise is understandably lower than after a fall as detailed in the previous question. Interestingly, though, if a stock has gained over the last few days, you would do better to avoid short-term bets for most stocks – although CAT stock appears to be an exception to this general observation.

[Updated: 5/14/2021] CAT Stock Overvalued

We believe that the Caterpillar stock (NYSE:CAT) looks richly valued at current levels of around $240, and it is vulnerable to downside risk. CAT stock is up 2.7x from the levels of under $90 it was at in March 2020, compared to the S&P which has moved 84%. CAT stock has significantly outperformed the broader markets, primarily due to upbeat results over the recent quarters, improved demand outlook, and a sooner than expected rebound in the economy. However, the stock is up a large 128% in the last one year despite revenue falling 16% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for Caterpillar’s equipment, the positives appears to be priced in and CAT stock stock appears to have run ahead of its valuation, in our view. Our dashboard Buy Or Fear Caterpillar Stock provides the key numbers behind our thinking.

Looking at a longer time period, CAT stock is up 88% from levels of $127 seen toward the end of 2018. The rise in stock price over the last two years or so can be attributed to favorable changes in the company’s P/E multiple. Caterpillar’s revenues have trended lower, declining 24% to $41.7 billion in 2020, compared to $54.7 billion in 2018, primarily due to the impact of the Covid-19 pandemic on the demand for its equipment. The impact of the pandemic was visible not only on the top-line but also on margins, due to increased operating costs. The company’s net margins declined to 7.2% in 2020, from 11.2% in 2018. Caterpillar spent close to $9 billion on share repurchases between 2018 and 2020, resulting in a 8% drop in total shares outstanding. As such, on a per share basis, earnings plunged 47% to $5.51 in 2020, compared to $10.39 in 2018. Even if we were to look at adjusted EPS, it declined 42% to $6.56 in 2020, compared to $11.22 in 2018. Despite a large decline in EPS, the company’s P/E multiple expanded from levels of over 12x in 2018 to 33x in 2020. The P/E multiple has further increased to 43x now.

Outlook

2020 has not been a great year for Caterpillar’s revenue growth, given the lower demand for equipment across its verticals – construction, resource, and energy & transportation. This can be attributed to the impact of the pandemic on the non-residential construction, and lower demand for energy. That said, the company has seen a rebound in demand, evident from its Q1 2021 results. Caterpillar reported 12% growth in its top-line, led by a solid 26% growth in construction equipment sales. The company reported net margins of 12.9% during the quarter, 80 bps higher compared to 12.1% in the prior year quarter. Now, given that over 46% of the U.S. population has received at least one dose of Covid-19 vaccine,  the economy is expected to see a rebound in growth, boding well for Caterpillar’s business.  However, the positives appear to be already priced in the current value of $240 per share for CAT.

Caterpillar is expected to post revenues of $49.3 billion in 2021, up 18% y-o-y, while its earnings are expected to grow at a faster pace to $9.75 on a per share and adjusted basis, implying 49% y-o-y growth, led by a strong rebound in margins as well as the impact of share repurchases. At the current price of $240, CAT stock is trading at 25x its 2021 expected EPS of $9.75. This compares with levels of 11x and 13x seen in 2018 and 2019, respectively. In fact, even if we look two years out, CAT stock is trading at 20x its 2022 expected EPS of $11.90. Overall, given the large rally over the last year, and going by the valuation multiple, we believe that CAT stock is now vulnerable to downside risk.

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