Why This Manufacturer is Committing to a Massive Buyback Program

Key Points

• Caterpillar management is looking to buy back over 10% of the company's outstanding shares today in a $21.8 billion program. 
• As nations start stockpiling gold reserves to finance new infrastructure and construction projects, Caterpillar's exports are set to rise.
• Wall Street analysts reiterated a double-digit upside for Caterpillar stock in the following quarters. 

The market is still going on about the technology sector; all the hype around artificial intelligence is starting to cool down as there is a systemwide rotation into other areas in the financial markets. Wall Street giants like Stanley Druckenmiller revealed some of these areas, as he sold out of technology and into two main areas.

One area where Druckenmiller found upside potential was small-cap stocks, which he allocated to the iShares Russell 2000 ETF NYSEARCA: IWM since small businesses typically outperform during a new interest rate cycle. Solidifying his view on the Federal Reserve cutting interest rates, Druckenmiller also bought the iShares 20+ Year Treasury Bond ETF NASDAQ: TLT. Here’s what investors need to know about lower interest rates.

They also bring on lower mortgage rates and higher commodity prices, among other things. Gold prices are now at an all-time high, and nations like China keep stockpiling the precious metal, which, believe it or not, will be a bullish indicator for one stock in the construction industry. Caterpillar Inc. NYSE: CAT management knows what’s coming, and they’re putting a few billion aside to squeeze the potential rally.

Gold Reserves and Construction: An Unexpected Relationship

Countries need to be able to print money and finance their projects by selling bonds to other countries. However, other countries might not want to invest in a weak currency or economy since it’ll probably be a bumpy road. A country can create confidence for potential financiers by increasing its foreign currency reserve or stockpiling gold.

Investors should monitor the relationship between the countries importing a lot of gold and increasing their infrastructure and construction budgets. Why? Caterpillar might be in the middle of an action that will spike worldwide, and being an international company sometimes has its perks.

Turkey, India, and China are among these countries. Not only have they been stockpiling gold lately, but they have also continuously increased their construction and infrastructure budgets. Another thing these countries have in common is that all three of them import their machinery from Caterpillar.

To tie it all together, investors should know that lower interest rates could also bring a downside to the dollar index. A weaker dollar will boost exports as foreign currencies are stretched to buy more American goods, increasing earnings for stocks like Caterpillar.

The Clear Uptrend in Caterpillar Stock

Starting with price action and momentum, Caterpillar stock trades at 92% of its 52-week high price. Still, some in the market believe it could go even higher, even a new all-time high, as the previous was $382 a share.

Analysts at Goldman Sachs still stand by their price target for Caterpillar stock, set at $408 a share. This target not only calls for a new all-time high but also dares the stock to rally by as much as 16.4% from where it trades today.

The forecast for Caterpillar stock’s earnings per share (EPS) is set to grow at only 5.7% in the next 12 months, which might be on the conservative end of the spectrum and due for a revision, particularly considering the sorts of tailwinds that are about to hit the company’s financials.

But these analysts aren’t the only ones in the market willing to share their optimistic views with the public. Investors can decrypt the market’s message about a company’s value. In the case of Caterpillar, one valuation multiple makes it a clear positive outlier compared to the rest of the industrial sector.

Trading at a 9.1x price-to-book (P/B) ratio commands a premium of over 150% compared to the industrial sector’s average 3.7x P/B valuation today. There’s typically a reason why markets will bid a stock near a new all-time high while also paying a premium valuation, and investors now have a good idea of what that reason may be.

Caterpillar Management's Bold Bet on Future Growth

Based on these tailwinds, Caterpillar management approved a $21.8 billion buyback program. This program is a bet that the company is cheap today compared to what it could be valued shortly.

Investors can use Caterpillar's first quarter 2024 earnings presentation to justify this buyback program, as the company is now riding on significant financial momentum. The key takeaways were a 29% annual jump in operating profits and a 54% jump in EPS (which is significantly above analyst forecasts).

These gold stockpiling nations, readying for a construction spree, might have already placed their interests in Caterpillar's machinery. Order backlog rose by $400 million over the quarter, which, of course, gave management confidence to increase their guidance for the rest of the 2024 fiscal year.