👷🏗️Business Overview

🎯Key Metrics

Total: 9/17

• +2 ✅ Projected Operating Margin: 21.04%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 4.21%
• +1 ✅ Last 5-Year ROIC: 16.00%
• +1 ✅ Estimated Cost of Capital: 10.19% (less than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -3.67%
• +1 ✅ Projected 5-Year EPS CAGR: 12.71%
• +0 ⚠️ Projected 5-Year Dividend CAGR: 6.73%
• +1 ✅ Moody’s Rating: A2
• +2 ✅✅ Morningstar Moat: Wide
• +0 ⚠️ Morningstar Uncertainty: Medium

Caterpillar is a very mature company in a cyclical industry. Its competitive advantages and Wide Moat rating shows on its high operating margin. It grows its revenues around economy growth rate, justified by the maturity of the business, and its dividends a little above it around ~6%. Its capital allocation is solid earning a higher rate than its estimated cost of capital.

Let’s check below if the current valuation of the stock is justified.

📈Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projecting the EPS CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/E – we assume mean reversion to the historical P/E values;
• Historical EV/EBITDA – we assume mean reversion to the historical EV/EBITDA values;
• Historical Dividend Yield – we assume mean reversion to the historical dividend yield;
• Historical P/CF – we assume mean reversion to the historical P/CF values.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 10.19%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 35%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital – I’m assuming the cost of capital converges long term to the industry average.
• Initial and Terminal Tax Rate – I’m assuming here the industry average for both values, given the proximity of recent averages for the company.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 220.15 dollars for Caterpillar.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

Some notes on the inputs above:

• Initial and Terminal Cost of Capital – I’m using a pre-defined range between its current estimated cost of capital and the industry average;
• Terminal ROIC – Here I overwritten the default value, that is the terminal cost of capital, to allow for a maximum input of 15%, a value still below its historical averages but above the terminal cost of capital.

As you can see from the above Caterpillar seems to be overvalued given that its current price of 690.91 dollars is well above P90 (almost 3x…). From these simulations we can extrapolate that there’s more than 90% probability that the stock is overvalued at the current price.

This is only a single output, let’s check the other valuation methods, so we can get a clearer view.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 20%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 20 PE for the company, so below its current value but still around its 5 Year average of around 19-21.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Using this valuation method, Caterpillar that is currently priced at 690.91dollars seems to be overvalued being currently valued well above P90. From this we can extrapolate that there’s more than 90% probability that the stock is overvalued.

Despite this giving us a higher value than the previous DCF valuation, still gives us the output that the company seems to be overvalued.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical P/E (Weight: 15%)

The current P/E (Price / Earnings) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 20.73 we can assume a fair value of 217.81 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

Historical EV/EBITDA (Weight: 15%)

The current EV/EBITDA (Enterprise Value / Earnings Before Interests, Taxes, Depreciation and Amortization) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 14.85 we can assume a fair value of 210.52 dollars.

Historical Dividend Yield (Weight: 10%)

The current Dividend Yield ratio is below its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 1.90% we can assume a fair value of 327.52 dollars.

Historical P/CF (Weight: 5%)

The current P/CF (Price / Free Cash Flow) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 15.66 we can assume a fair value of 223.14 dollars.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I will pick a fair value of 240.80 dollars because I think Caterpillar deserves a “High Confidence” rating given its grip on the construction industry as a whole.

Please, as always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

Overall it seems Caterpillar is overvalued at the current prices.

Fair Value: 240.80 dollars