DGI Adventure – 11-20-2015 Payday! And Investment Thesis – Caterpillar Inc. (CAT)

Today I received $15.40 in dividends from my 20 shares of
CAT. Woo hoo!

I purchased CAT on 8/24/15, which you may remember was a
hectic day. Mr. Market had gone off his meds, the robots had gone haywire, and
actual real-life humans were doing some bizarre things with actual real-life
money. All in all it was a pretty good day to be buying stocks. I picked up 20
shares of CAT at $73.50 for a total investment of $1,476.95 (including $6.95
trade commission). I hadn’t yet finalized my investment thesis structure, but
that process was in development so I had been looking at a lot of the same
metrics I look at now (although not all). I felt pretty good about myself for
about a week until some pretty ugly headlines drove CAT much lower to the point
where it set its current 52-week low ($62.29) about a month later. The share
price has recovered from those depths, but it’s still showing an imaginary loss of about
3.5% (closing price of $71.14/share today).

It’s entirely possible there will be more pressure on the share price over the coming months, so it’s worth determining if I’m interested in averaging down or not. I’ve decided to take this opportunity to run through my
investment thesis process
and see how I feel about CAT now that I have a
more systematic way of looking at stocks.

Dividend Cycle

I wish I had paid more attention to the dividend cycle when
I made this purchase. The share price was under a lot of pressure last quarter
and I bought a full two months before the ex-dividend date in October. I could have
gotten a much better purchase price if I’d been more patient.

CAT should go ex-dividend again around mid-January 2016. The
current quarterly dividend is $0.77/share where it’s been for the past two
quarterly payments. It’s unlikely to be raised in the coming quarter since 1) the
dividend was recently increased 10% between Q2 and Q3 from $0.70/share and 2) the company
is laying people off and facing a historically challenging down market cycle.
CAT is a dividend
contender
having raised its annual dividend 22 consecutive years. Even if there is no increase in 2016, the
company can maintain its streak with the current quarterly payment. Since the 2015 raise came mid-way through the year, the current dividend
projected across all four quarters of 2016 would still be more than the total 2015 annual
payout.

Investment

I do not have any current plans for additional investment in
CAT. I would expect any future purchases to adhere to my maximum trade
commission of 0.5% or less, which represents a ~$1,400 minimum investment.

The
QC (Quantitative Case)

image

NOTES:

Yikes! That is a lot of yellow. The revenue and EPS CAGRs
are only as good as they look because I used 2005-2014 fiscal year numbers. Using
2006-TTM is worse. 2015 isn’t going to be a great year. This is the flip side
of the hindsight coin. Had I been following my investment thesis process, I
might have been more patient given the dividend cycle. I also might not have
pulled the trigger given the mediocre quantitative case.

I can forgive the low return on assets as Caterpillar has a
lot of money tied up in equipment and manufacturing capacity.

The debt is an issue for me. The dividend cushion is
inherently conservative, as CAT doesn’t have to pay off ALL of its long term
debt in the next 5 years. Good thing…because they can’t afford to. But they’re highly leveraged at over 90% of market capitalization. To be fair, the
stock has been crushed over the last year and a half, so a lot of market cap
has vaporized. As recently as July of last year, the stock was trading at
$111/share, which would be north of a $60B market cap. Even at that valuation,
that’s still too much debt.

If there’s any good news the payout ratio isn’t horrible. It
will go north of 60% this year based on projected earnings estimates. TTM (well…through
9/30/15) cash from operations is $6.7B while investments were only $2.6B and dividends
paid is $1.7B. So the payout ratio in terms of free cash flow is even better at ~42%. I always have to remind myself that “earnings”
are kind of imaginary numbers. I might change my QC metric to a payout ratio
based on cash flow instead of earnings. Stay tuned.

Limit Order Logic
(LOL) – $XX.xx/share

I’m not planning to make another investment in CAT any time
soon, and I don’t intend to tie up any cash with a limit order. Its 200-week
moving average is $58.94. The last time it was below the 200-week moving
average was in the depths of the great recession. Give me another 20% drop and I’ll
think about it so long as we’re still cash flow positive and management has
made some kind of commitment to lower the company’s leverage.

QWaF (Qualitative
Warm and Fuzzy)

This post is already too long, so I’ll keep the hand-wavy
stuff to a minimum. It’s freaking Caterpillar. Their scale is immense and they
enjoy a dominant position in terms of their market share. The company has been
around a long time and weathered its share of down cycles. Throughout those
cycles there is a rich history of rewarding shareholders with dividends.

CPR (Cold and Prickly
Risks)

That said, this is definitely a down cycle. The company has
an uncomfortable amount of debt for my taste, and the current global picture
for commodities (mining companies being CAT’s biggest client base) is anything
but rosy. The company is in hedgehog mode, and a 6.5% DGR is probably overly
optimistic for the next few years. But the dividend isn’t in danger of being
cut, which means they’ll pay me a 4.2% invested yield while we wait for the
next upswing, and I’m okay with that.

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