Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Wall Street has been wearing rose-colored glasses when it comes to Caterpillar Inc. After the tractor maker's earnings Tuesday, they're also seeing green. 

The $64 billion maker of bull dozers and excavators reported better-than-expected second-quarter results, justifying a major boost to its full-year outlook. Caterpillar now expects about $5 in adjusted EPS at the midpoint of its (also increased) revenue guidance. Not only is that a third higher than what Caterpillar had projected in April, it exceeds analysts' estimates that before Tuesday's report were arguably looking over-eager.

Eager Beaver
Analysts were expecting Caterpillar to raise its full year guidance -- by a lot -- and it still exceeded their expectations
Source: Bloomberg

Such optimism has become something of a pattern among Caterpillar followers, who have regularly been more enthusiastic about its recovery than even the company itself. With Caterpillar shares skyrocketing more than 6 percent percent in early trading, such a sunny disposition is seeing its reward. That said, there is still such a thing as too much optimism and investors should be wary of a further push upward in Caterpillar's stock price and those profit forecasts.

Rock Climbing
Caterpillar has been one of the biggest gainers on the Dow Jones Industrial Average this year and has also outpaced other benchmarks. It's adding to that outperformance in pre-market trading on Tuesday.
Source: Bloomberg
Date is as of market close on July 24.

Based on typical valuation multiples during economic swings, Caterpillar's pre-earnings report stock price was implying a jump to $12.50 in EPS when it reaches the peak of its profit recovery in a few years, according to Jefferies analyst Stephen Volkman. The last apogee for Caterpillar's earnings in 2012 was just under $9. It's an open question whether Caterpillar's earnings power can even recover that far as commodity prices remain volatile and companies prioritize cutting debt and raising cash flow over new investments.

While one big reason for Caterpillar's improved outlook was increased demand across many of its markets, including a rebound off of the lows in demand for its mining and oil-related equipment, it cautioned that there were still lingering risks. Caterpillar's head of investor relations noted in June that it was keeping "constant watch" on crude prices, which have been trading below its comfort level of $50.

Cost cuts seem to be paying off, as the restructuring charges rack up. Notably, however, Caterpillar specifically highlighted its interest in making "targeted investments" to enhance its digital capabilities. It plans to do this without adding to the costs it's worked so hard on trimming back, but it's hard to launch a full-scale investment in technology without an impact to margins (see General Electric Co.).

Throwing caution to the wind has worked out well for Caterpillar investors so far. But at some point, all that enthusiasm could come back to bite.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net