Four years ago, I recommended heavy equipment manufacturer Caterpillar (NYSE: CAT) to my Personal Finance subscribers. I said then, “Increased infrastructure spending becomes more likely with every week that the coronavirus pandemic shuts down the U.S. economy.”

At that time, I believed members of Congress from both parties up for reelection that fall would approve a major infrastructure spending bill. Voters tend to remember who just sent millions of federal dollars into their districts.

Turns out, my timing was a bit premature. Such a measure would not be passed into law until seventeen months later.

Nevertheless, my original thesis for owning Caterpillar remained intact. “No matter how the infrastructure money is allocated, whoever ends up doing the work will need to purchase the type of heavy equipment manufactured by Caterpillar.”

And purchase the type of heavy equipment manufactured by Caterpillar they did. On February 5, Caterpillar released its fiscal 2023 full-year results. Those numbers included a 19% jump in revenues. That follows a 17% increase in sales over the year before that.

Those are the kind of numbers that Wall Street likes to see. Over the past fifteen months, CAT has generated a total return (share price appreciation plus dividends paid) of 100%. Over the same span, the SPDR S&P 500 ETF Trust (NYSE: SPY) has gained 39% as shown in the chart below.

Seller’s Market

There is a lot more to this story than a spike in demand for heavy equipment. That type of machinery is expensive to acquire. For that reason, most of Caterpillar’s sales are made using some form of credit.

Two years ago, the Fed began raising interest rates to tamp down inflation. As interest rates rose, so did the cost of borrowing money.

Wall Street assumed that Caterpillar would suffer a big drop in sales due to higher borrowing costs. That’s not an unreasonable inference given how aggressively the Fed was raising interest rates.

For that reason, Caterpillar’s share price fell during the first nine months of 2022. At that point, CAT had performed no better (nor worse) than the S&P 500 Index since I recommended it in April 2020.

A few weeks later, Caterpillar released its fiscal 2022 Q3 results. The company surprised Wall Street by reporting a 21% year-over-year increase in total revenues.

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A big chunk of that gain was due to “price realization.” That refers to the net price of the equipment sold after subtracting discounts and other financial incentives. In this case, there wasn’t much to subtract.

Due to surging demand, Caterpillar did not have to discount its merchandise as much to capture sales. With a trillion dollars of new infrastructure money in play, contractors have been bidding against one another to obtain Caterpillar’s construction equipment.

As a result, the company’s operating margin expanded from 13.4% to 16.2%. In turn, Caterpillar reported record adjusted profit per share for the third quarter.

That news changed Wall Street’s perception of Caterpillar. Since then, it has more than doubled the performance of the S&P 500 Index.

Buyer’s Remorse

Caterpillar may have caught Wall Street by surprise two years ago, but the CAT is out of the bag now. Its PEG (price/earnings-to-growth) ratio of 1.9 is nearly twice what legendary mutual fund manager Peter Lynch felt was a fair price to pay for a growth stock.

However, its forward PER (price-to-earnings ratio) of 16 is well below the multiple of 22 for the S&P 500 Index. That discount may be due to the same factor that drove its share price so high. Namely, how much longer will the infrastructure money last?

Once that money runs out, Caterpillar may have difficulty maintaining its revenue growth rate in the United States. That is a concern since the company booked lower sales volume for its Construction Industries segment during the fourth quarter in all of its international markets.

Apparently, that’s a worry for another day. In its guidance for the current year, Caterpillar anticipates “2024 full-year sales and revenues to be broadly similar to 2023.”

If that expectation comes true, then Caterpillar’s share price should continue to appreciate. But if it does not, then the investors buying it now may end up with a case of buyer’s remorse.

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