Caterpillar: Dividend Trends By The Numbers (NYSE:CAT)

Intro

If we pull up a long-term chart of Caterpillar Inc. (NYSE:CAT), we can see that shares are once more toying with long-term resistance which dates back to early 2021. Although some analysts have been clear with their intentions with respect to not seeing a firm breakout any time soon, we would caution investors from taking profits here at this stage.

The rally over the past three months for example in CAT has been extremely aggressive in nature and it is not the company’s fault that the market continues to love this stock. Although shares do not look frothy on the earnings side (GAAP multiple of 17.40), Caterpillar’s sales and assets (P/S of 2.25 & P/B of 7.99 respectively) definitely look overextended compared to historic valuation multiples.

However, deciphering a stock’s potential is all about sizing up the trends of the company’s valuation and profitability. Caterpillar’s trailing return on equity comes in at 45%+ at present, which partly explains that overextended valuation on the sales side. Another crucial area is the sustainability of the dividend. By evaluating the trends of the key metrics which make up the payout, we can gain more insights into the profitability of the company. Suffice it to say, a well-funded growing dividend usually points to more gains in the share price before long.

Dividend Yield

Caterpillar’s dividend yield comes in at 2% working off an annual forward payout of $4.80 per share. The manufacturer’s 5-year average yield comes in at 2.4% so long-term investors may deem shares to be overvalued at this juncture. Although the prevailing dividend yield is not a strong calling card at this juncture, Caterpillar has raised the dividend every year for the past 29 years with the next quarterly hike expected in July of 2023. Therefore one is giving up some yield here for the security that Caterpillar offers to long term investors.

Dividend Growth

Furthermore, given the high inflationary environment, we are going through at present, dividend growth rates are crucial in order to protect purchasing power. As we can see below, there is very little between Caterpillar’s prevailing dividend growth rates over various periods in the past decade. Furthermore, near-term growth rates continue to keep up with inflation which is crucial for income-orientated investors.

Dividend Growth Rate	7.94%	6.92%	8.31%	8.92%
Period	12-Months (TTM)	3-Year (CAGR)	5-Year (CAGR)	10-Year (CAGR)

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Dividend Safety

We prefer to use the free cash-flow pay-out ratio as cash at the end of the day pays dividends to shareholders and not net earnings. Over the past four quarters, the cash-flow pay-out ratio comes in at 64.58% which is marginally higher than Caterpillar’s 5-year average of 59%. Anything around 60 to 65% really is in the wheelhouse of dividend-paying companies. We state this because if the payout ratio is too low, investors believe management is not paying enough out to its shareholders whereas when it is too high, the dividend may not be sustainable. Cash flow though as we know can be generated in a myriad of different ways. Therefore by going through trends in Caterpillar’s debt metrics as well as how analysts are expecting earnings to fare going forward, we can gain insights on how much cash flow will be essentially there to keep on growing that dividend over time.

Interest Coverage Ratio

This ratio is a key ratio when evaluating the future growth potential of the dividend as it enables one to see how much of the company’s operating profit is dropping to the bottom line. Remember, free cash flow is derived from net profit so the less interest expense eats into Caterpillar’s profits over time, the better for dividend investors. Caterpillar’s trailing 12-month interest expense of $438 million when divided into the trailing operating profit figure of $8.98 billion gives us an interest coverage ratio of 20.47. This is well ahead of Caterpillar’s 5-year average of 15.8. Encouraging.

Debt To Equity

In terms of the balance sheet, Caterpillar’s debt-to-equity ratio now comes in at 233% which is slightly behind the company’s 5-year average of 243% for the same metric. Although this metric may seem high on the surface, the company’s treasury stock ($30.8 billion) & retained earnings ($43.3 billion) line items continue to grow significantly which is encouraging. Suffice it to say, Caterpillar has always reported a pretty high debt-to-equity metric but we see no impaired conditions here.

Expected Earnings Growth

As we see below, analysts who follow Caterpillar expect the manufacturer to average strong double-digit bottom-line growth over the next three years. if these numbers get met, for example, the fiscal 2024 earnings multiple comes in at a very reasonable 14.4. Suffice it to say, if earnings revisions continue to impress (As they have been doing), Caterpillar could easily break out of the technical pattern alluded to earlier as the market would have to reward the company appropriately. From a dividend perspective, we see no issue with growth continuing here into its thirtieth year.

Conclusion

Investors are still deciding whether Caterpillar (currently revolving around the $240 mark) will undergo a false breakout or not. From a dividend standpoint, the company looks in excellent shape with earnings and cash flow expected to keep on fueling the growth of the payout. Watching closely. Let’s see what January brings.