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One Hundred Years Paying Dividends: Caterpillar's Share Price Is Overvalued

February 12, 2014 | About:

On Dec. 31, Mark Hillman (Trades, Portfolio), the president of Hillman Capital, bought Caterpillar Inc. (CAT) and currently holds 30,441 shares of the stock. Let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not.

The firm is the world’s largest supplier of heavy machinery. Despite that it holds a dominant share in the U.S., the company is also a leading exporter. The company paid $8.8 billion in 2011 for acquiring Bucyrus, the mining equipment manufacturer, searching for synergies (over $500 million annually by 2015), the capture of aftermarket parts and services business, and cost savings in the areas of purchasing and engineering. A substantial portion of its operating profits are from the mining end-market. In this sector the company benefits from an oligopoly-style market structure (high barriers to entry and pricing power).

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends, getting the John Burr Williams´s original DDM formula:

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high-growth stage until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic:

The growth rates are:

Year

Value

g(t)

1

g(1)

17,17%

2

g(2)

17,50%

3

g(3)

17,84%

4

g(4)

18,17%

5

g(5)

18,51%

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

  1. Calculation of Intrinsic Value

Year

Concept

Amount

Present value

0

Div 0

2,32

 

1

Div 1

2,72

2,24

2

Div 2

3,19

2,17

3

Div 3

3,76

2,10

4

Div 4

4,45

2,05

5

Div 5

5,27

2,00

5

Terminal Value

214,70

81,37

Intrinsic value

   

91,92

Current share price

   

94,50

Final Comment

When the stock price is greater than the intrinsic value, the stock is said to be overvalued and it makes sense to sell the stock. I would advise fundamental investors to stay away from this stock according to our estimations.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio), Mario Gabelli (Trades, Portfolio) and Jim Simons (Trades, Portfolio) sold this stock.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


Rating: 4.3/5 (9 votes)

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