Caterpillar's Earnings Offers Warning About The Economy

As a general rule, investors should be wary of placing too much weight on any one company’s earnings report. There are so many variables that contribute to revenue and EPS that drawing broad conclusions about the market or the economy from one company’s results is almost impossible.

As with all rules, though, there are exceptions. Caterpillar (CAT) has always been one of those exceptions. Their dominant role in the global heavy equipment market and the fact that they are a reliably efficient, well-run company adds significance to their take on economic conditions.

When CEO Doug Oberhelman said in a note accompanying this morning’s report that 2016 was a “challenged environment” and that 2017 performance was expected to be no better, therefore, traders and investors should take notice.

Caterpillar’s take on overall economic conditions in the world is a relevant one because the business they are in, providing equipment for mining, construction and transportation, is so fundamental to growth. If demand for materials and construction is slack on a global basis, then businesses are not anticipating good times. If the reverse is true, then any current weakness is obviously only going to be temporary, and make no mistake: this was a pretty depressing report.

That comment may puzzle some; I mean, after all, CAT did beat expectations for EPS, right? Well, yes, but as is increasingly becoming clear this earnings season, that is not the point. Around two thirds of companies reporting will beat expectations this season, but that has to do with where those expectations are set more than anything else. Traders and investors are becoming increasingly wary of a beat of lowered expectations.

There are other things that really matter in CAT’s report, and they help to explain why, despite EPS of 85 cents vs. the expected 76 cents, CAT is trading lower in the pre-market this morning. What is weighing on the stock this morning is that the Caterpillar management lowered their guidance for both the rest of this year and next year.

Earnings per share for the last quarter may be the headline number, but far more significant for the price of a stock is what management sees as the prospects going forward based on orders coming in. After all, as the old saying goes, one swallow doth not a summer make.

If you take the performance and prospects of Caterpillar as being indicative of strength in the global economy though, what is most worrying about this report is that $0.85 in EPS and $9.16 billion in revenues represent a significant decline on last year’s numbers for the same quarter, which came in at $1.05 and $10.96 billion, yet the stock has made significant gains over the last 12 months.

That makes it clear that the market is betting on conditions improving for the company soon, but that lower guidance suggests that that is not about to happen.

If that were the case for only Caterpillar, then it would be simply an error in forecasting, and the price could fall slightly and then stay steady as economic growth catches up.

Unfortunately though, that is not the case. These results reflect a trend in this season’s earnings, a trend that sees lower revenue and profit than at the same time last year and some pessimism about the near future, even as stock prices hover around record highs.

Something has to give.

Of course, there are reasons for that discrepancy. For a start, easy monetary policy around the world has created a glut of capital chasing returns, and equities offer better prospects than most other investments. In addition, there is a feeling among many that CEOs are generally much too cautious in their outlook. Understandably, they work on the basis that it is best to under promise and over deliver than the other way around.

The fact is that what Oberhelman offered this morning was a further downward revision of already cautious estimates. Pile that on top of an overall decline in earnings last quarter and the aforementioned highs in the stock market and it should serve as a fairly clear warning to investors.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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