Hello,
I usually screen my companies using David Fish’s CCC list. For this month, I used the following criteria:
 Yield over Avg Yield > 1.10
 Payout Ratio < 0.8
 Chowder > 10
 PE over Median PE < 1.0
Basically, the screen looks out for companies with lower than average P/E and higher than average yield. I also wanted a high Chowder to make sure that the company has enough dividend growth. Lastly, I further filtered out companies based on excellent (A) credit ratings.
You can review my July screen here:
Then, I fully research these companies and invest accordingly.
If you follow my blog, I bought 15 shares of CAT at $80 last week (before the bigger dip).
Date

Action

Security

Price

Quantity

Amount

7/22/2015

Buy

CAT

80

15

1206.95

This article is a more detailed analysis of CAT from my notes.
Caterpillar (CAT) Dividend Stock Analysis
Caterpillar (CA) manufactures heavyduty vehicles and technologies designed for constructing buildings and mining the earth. Worldwide, Caterpillar is the leading manufacturer, by revenue, of engines and turbines used in machinery, electric generators, highway and nonhighway trucks, and seaborne vessels.
Caterpillar (CAT) plays in the largecap, international Construction, Agriculture and Machinery Industry. Other companies include Deere & Company (DE), Komatsu and Volvo.
Source: Wikinvest
Criteria List
CAT 7/2015

Area

Criteria

CheckList

Comment

Quality Company

Dividend Growth

>5 years

Yes

21 Years

ROE/Op Margin

Stable

Yes

Stable
 
Long term Avg Growth

Stable

Yes

Stable
 
FCF over Dividends

Yes

Yes

FCF covers Dividends
 
M* Moat

Wide Moat

Yes

Wide
 
M* & S&P
Credit Rating

> BBB+

Yes

A
 
Cash to Debt & Interest Coverage, Debt to Equity

Cash Debt >1 or Interest Coverage > 5

No

Cash to Debt 0.2
Interest Coverage 4.81
Debt to Equity 223.3
 
M* & S&P Stars

> 3 Stars for both

Yes

M* 3 Stars
S&P CapIQ 3 Stars A rated
 
Payout Ratio

<60%

Yes

48.00%
 
Dividend Growth
& Yield

Dividend Yield

>3%

Yes

4.00%

Dividend Growth

>5%

Yes

6.70%
 
Chowder

>12%

No

10.70%
 
Valuation

Yield/Avg Yield

>1.1

Yes

1.67

Dividend Yield Theory Mid Point

Below Mid Point

Yes

Mid Point 122.63
Low Point 62
 
P/E

Below Mid Point

Yes

Median 14.67 Current 13.28
 
DRRM

~10%

Yes

Assuming 5% growth; projected return=10.72%
 
M* Estimate

<M* est

Yes

M* 79
 
S&P Estimate

< S&P cap IQ est

Yes

S&P Cap IQ 90

Source: data from M*, Yahoo, Gurufocus and CCC
Quality analysis
Years of Dividend raises
CAT has 21 years of dividend raises. Normally, I prefer a company with dividend growth > 10 years. As you can see, they have raised their dividends regularly.
Stability of key metrics
These stability of the ratios provide an indication of moat & management strength. I am looking for overall stability (or even better  growth). If the ratios decline year over year, then this is an indication of moat reduction and poor management. I also compare these ratios with other companies within the same sectors.
The ROE is currently at 20.1 which is higher than 89% of the 134 Companies in the Global Farm & Construction Equipment industry.
Apart from the dip in 2010 and 2011 the ROE and OM are quite stable. The industry is very cyclical  we should expect dips as part of the normal cycle.
Free cash flow over dividends
I use the free cash flow per share and compare this with dividends per share. FCF should cover the dividends.
As you can see, the FCF covered the dividends for most parts with an exception of 2009 and 2013.
Average growth
Here, I look for the stability of growth indicators over ten years using the EPS and Revenue.
So, in general, the EPS and revenue are growing from the last 10 years. There is a dip in 2010.
The 10 years averages look reasonable with the exception of 2010.
The 3 years averages clearly show the cyclical nature of the business.
EPS Analysis
It is good to review the actual earnings and number of outstanding shares to see exactly how the EPS grows.
As you can see, the EPS is very correlated with the earnings. Overall, there is a slight decrease in shares but it is not really impacting the EPS metric.
EPS and Price
Eventually, a lack of earnings over a long period of time will drive a stock price down and the company potentially out of business. On the other hand, a rising EPS will have a positive impact on price.
The correlation is fairly tight in the case of CAT. In particular, it is interesting to see the price dips before the actual EPS drops.
From a dividends stock perspective, a growing EPS is important for continued dividends growth.
Overall, the EPS has been growing since 2006. There is a large drop during the large recession, but CAT quickly recovered. There is another drop in 2012.
S&P Capital IQ 3Yr. Projected EPS CAGR(%) is around 7%.
Guru 3Yr. Projected EPS CAGR(%) is around 7.4%.
Therefore, there is a mixed consensus on EPS growth. My inclination is that the future EPS should be flat to negative.
M* Moat
I simply use the moat indicator from M* to validate my findings. M* indicates that CAT has a wide moat. It is clear why CAT has a wide moat  there are only a few companies that provide the equipment for construction  CAT, DE, Volvo, KUB.
Credit rating
Here, I look for companies with credit rating of BBB+. Just like banks wanting good credit from you when you apply for a loan, you want companies which are stable from a credit perspective.
CAT's credit rating from M* is A which is a good indication of the security of the company.
Debt
I look at the debt to equity ratio (<50) and cash to debt (<1) and interest coverage (>5). Sometimes, a little good debt is good for a business. But too much debt can be a burden.
CAT's Cash to Debt 0.2 with Interest Coverage at around 4.81 which debt is just below my threshold is 5. The TTM Debt to Equity is around 223 which is way above my 50% threshold. Ordinarily, this is a bad thing, but from analyzing the industry in general, this seems to be the norm.
Over the last 10 years, the debt to equity > 100%.
M* and S&P capital IQ rating
I am looking for 3 stars and above from either. A four/five star is a bonus.
M* gives CAT 3 Stars and S&P CapIQ gives 3 Stars with A rating
CAT combined stars is 6  which means it is an indication to buy.
Dividend Yield and growth
 Dividend yield is 4.0% which is above my threshold of 3%.
 5Y CAGR dividend growth is above 6.7% which is much higher my threshold of 5%.
 Chowder is around 10.7% which is below my 12% threshold.
Normally, I prefer a chowder > 12%, but for a company with a long dividend growth streak, a slightly lower number is acceptable.
Payout Ratio
The TTM payout ratio for CAT for the recent quarter is around 48% which is below the threshold of 60%. For the last five years, CAT has a payout ratio under 30% with the exception of 2010.
Value analysis
Average yield
The current yield per average yield for 5 years ratio is >1.67. I use this as a quick indicator for valuation.This basically means that CAT's current yield is almost 67% over the average yield  which means that it is under fair value.
Dividend Yield Theory Mid Point
Using the dividend yield theory spreadsheet (based on the Dividends Don't Lie book), I calculate the mid and high points for the yield, from which I derive the price.
Note: You can get the spreadsheet at: http://div4son.blogspot.com/2015/03/dividendyieldtheoryspreadsheet.html
I estimate the high and low yields to be:
High

4.50%

Low

1.70%

Which produces the high and low boundaries.
This gives the following high, mid and low price ranges.
High Price:

183.04

Mid Price:

122.63

Low Price:

62.23

CAT's current price is in between 7580 which means it is between the Mid and the Low price range.
P/E Analysis
I can also estimate the fair value using the high and low earnings multiples based on the article and spreadsheet: http://div4son.blogspot.com/2015/06/usingpefordividendstockvaluation.html
I estimate the High and Low Earnings multiple to be:
High P/E

21.80

Mid P/E

15.80

Low P/E

9.80

Which gives an estimation of the price lines:
High Price

127.75

Mid Price

92.59

Low Price

57.43

The median and current P/Es are:
P/E 5 Yr Median

14.67

Current P/E

13.28

With the current price in between 7580, the P/E analysis is indicating that CAT is trading at the between the mid & low price point.
Dividend Drill Return Model
Also, using the DDRM model per the Dividend Playbook, I try to estimate the total return. Using the growth information from above, I estimate a conservative growth rate of 5.0. (S&P Capital IQ has a 7% EPS growth).
DDRM
 
Dividend Rate ($)

3.11

Divided by: share price

77.79

Current yield (%)

4.00

Core Growth Estimate (%)

5.00

Divided by: ROE (%)

20.73

Multiplied by: EPS ($)

5.86

Cost of Growth (%)

1.41

Earnings per Share ($)

5.86

Minus: Dividend

3.11

Minus: Cost of Growth

1.41

Funding Gap ($)

1.33

Divided by: Share Price ($)

77.79

Share Change (%)

1.72

Core Growth (%)

5.00

Plus: Share Change (%)

1.72

Total Dividend Growth (%)

6.72

Plus: Dividend Yield (%)

4.00

Projected Total Return (%)

10.72

CAT's projected total return is ~10.7% which is around my 10% threshold.
Rearranging the numbers based on the dividend growth & 5.0% growth:
Dividend Rate ($)

3.11

Required Return (%)

10.00

Growth (%)

6.72

Price

94.75

Dividend Rate ($)

3.11

Required Return (%)

10.00

Growth (%)

5.00

Price

62.23

Average

78.49

The average is around 78.
M* and S&P valuations
Morningstar CAT a target of $79. S&P capIQ gives a target of $90 Therefore, with a current price around 7580, CAT is just below the fair value.
Note: The whole point of all the valuation is to get a ballpark estimation. I estimate a fair value of in the ballpark of high 70s to low 80s.
Risks
 Caterpillar has a significant global market share position, but it trails Komatsu's share in China
 A decision to write off 80% of the value of the ERA Mining Machinery acquisition due to inflated receivables and accounting irregularities raises some concerns about Caterpillar's ability to successfully conduct international acquisitions.
 The company is more leveraged toward coal mining than natural gas extraction. A push to limit coal consumption in the U.S. and China (the two largest coal consumers in the world) is a net negative headwind for the company.
Source: Morningstar
Conclusion
CAT is in a very cyclical business. Based on the growth plots above, I see that there are some lean years. In a recent interview, the CEO also said that they will be ‘digging in’ (no pun intended) in the shortterm. His point is that the US and World economies are not growing fast enough.
However, my investment outlook is decades, so I think I am okay. I believe the dividends will be safe in the nearterm.
From a price perspective, I believe the current price (in the high 70s) is just below the fair price value (high 70s to low 80s). I see potential for the prices to drop further based on the negative EPS forecast from some analysts  which is okay with me. I will average down accordingly.
That's it for all. What do you think of CAT?
D4S
Div4Son,
ReplyDeleteWow... that's an insane analysis  aka it is great! Nice job putting that together, well done. I like the metrics and where it lies  mostly on the lowmid range. Seems to me that EPS is cyclical, shocker, and that share price follows suit. Guess what usually isn't that impact  the dividend!!! So that's the gravy right there, still increasing when times are tight, have to love it. I may buy more.
Lanny
Thanks Lanny for your comments. I agree with you that CAT is in a very cyclical business. I see some weaknesses in future EPS which could mean lower prices. The fact that management continued to give a dividend during previous dips means that I will be happy to add more on future dips.
DeleteGlad to be a fellow shareholder.
D4s
D4S,
ReplyDeleteVery thorough analysis. I've bookmarked it because I want to come back and read it again. I'm glad that you considered credit rating here. It's not mentioned a lot but, as you pointed out, it's a valuable indicator. I happen to like CAT a lot, but don't own any yet. Hoping to change that, too. Looks like a lot of fellow DGIers are doing that lately.
Dylan
Dylan, thanks for your input. I included the credit rating based on recommendations from several of the books I've read. When you use this in conjunction with the other indicators, you get a good sense of the company.
DeleteI like to add more CAT and DE in this space.
D4s
D4S,
ReplyDeleteAs everyone else here is saying, your analysis is excellent. To the point where it's intimidating!
I'm not sure what the majority of the items are in your criteria list, and I had a question about that. How do you weight each value in your criteria list? I mean, I'm picking based on very few criteria and this makes me think I'm only gleaning the surface of what I should be looking for. At least, once I venture outside of the sort of mega stocks I've been buying up, that is.
The items you consider seem deceptively simple, like you've condensed tons of understanding and a steep learning curve into a list of considerations.
I'm pretty sure that reading over all my comments, they probably all read pretty much like this one but posts like this make me realize how green I am.
Thanks anyway!
FM
FM, thanks for you comments. Don't be disheartened by the detail. It is actually quite simple  once you figure out what to look for (either trends or thresholds compared with historical info or competitors). I was going to write an article on what to look out for with references where I got the info (some books, some from bloggers)  but I always pushed it out. (It's summer after all. ) As always, it becomes easier with time.
DeleteI don't assign specific weights to my criteria decision. I look at all the yes's and no's and make a decision if the company is good or not. I don't expect to find a unicorn :)
Anyway, this is what works for me. The key is to find an 'analysis' method that you're comfortable with. if you have further questions on the specifics of the criteria, just ping me.
D4s