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Caterpillar vs. Deere: Which Is the Better Strong-Buy Rated Stock?

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Industrial production remained unchanged in May after registering its biggest gain in nearly three years in the prior month. Manufacturing output, which accounts for around 75% of total industrial production, decreased 0.4% after advancing in April. This was the second monthly fall in the last three months. Despite the decline in its biggest contributor, industrial output managed to remain flat last month following an increase in mining and utilities production.

In this context, it is wise to focus on two major industrial companies, Caterpillar Inc. (CAT - Free Report) and Deere & Company (DE - Free Report) . While both the behemoths have a Zacks Rank #1 (Strong Buy), it will be interesting to see which stock is better positioned in terms of fundamentals. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.  

Other industrial stocks from the Zacks Industrial Products sector which also carry a Zacks Rank #1 include Atlas Copco AB (ATLKY - Free Report) and Parker-Hannifin Corp. (PH - Free Report) .

Deere Beats on the Bourses

Over the last year, the industrial sector as a whole and the two stocks under consideration, have considerably outpaced S&P 500’s performance of 17.2%. While the Zacks Industrial Products sector has advanced 20.7% over the last year, Caterpillar has soared 40.8%. However, Deere has outperformed both Caterpillarand broader industry, surging 49.4% over the same period.

Valuation

The most appropriate ratio to evaluate these two industrials stocks is EV/EBITDA. This metric is usually used to compare two stocks within the same industry or sector. It is superior to other metrics such as P/E because it is not affected by the different capital structures of the two companies. Further, EV/EBITDA does not include the impact of non-cash expenses.

First, we have compared the broader industrial sector with the benchmark S&P 500 in terms of EV/EBITDA. For the last year, the S&P 500 has an EV/EBITDA value of 10.89, whereas the Zacks Industrial Products sector’s readings stand at 15. This clearly shows that the sector is relatively overvalued.

Coming to the individual EV/EBITDA ratios, both Caterpillar and Deere are underpriced, with readings of 12.93 and 13.89, respectively. Clearly, Caterpillar stands out in terms of valuation.

Inventory Turnover Ratio

Inventory turnover ratio evaluates the efficiency of an industrial company’s manufacturing process. A high inventory turnover ratio ensures that the company is able to manage its inventory effectively to generate revenues and avoid wastage.

This is one of the most important financial ratios, which is widely used by industrial companies to measure their ability to utilize their inventories. In the last year, the inventory turnover ratio for Caterpillar and Deere has been 3.08% and 4.75%, respectively, lower than the sector’s level of 5.4%. However, Caterpillar has registered better inventory turnover than its competitor.

Return on Assets

Return on assets (ROA) is one of the key financial ratios for industrials as they rely heavily on inventory to create revenues. Although they have a comparatively low level of net profit, an above-average ROA denotes that the company in question is generating earnings by effectively managing its assets.

A positive ROA indicates that the company has reported gains from its assets for the period in question. Coming to Caterpillar and Deere, ROA for the trailing 12-months (TTM) is 3.1% and 3.05%, respectively, which are below the industrial sector’s level of 5.4%. This round easily goes to Caterpillar.

Dividend Yield

In the last one-year period, the dividend yield for Caterpillar has been higher than both the broader sector and Deere. While the broader sector offered a yield of 1.81%, Caterpillar returned 2.86%. In comparison, Deere has a dividend yield of 1.88%.

Also, Caterpillar announced that its board of directors have approved a 1.3% increase in quarterly dividend to 78 cents per share after a hiatus of two years. The move reflects the company’s balance sheet strength and improved cost structure which has once again enabled it to deliver incremental returns to its shareholders. (Read more: Caterpillar Hikes Dividend After a Gap of 2 Years)

Earnings History, ESP and Estimate Revisions

Caterpillar started 2017 on a positive note. In the first quarter of 2017, Caterpillar delivered year-over-year improvement in both the top and the bottom line for the first time in 10 quarters. Adjusted earnings came in at $1.28 per share, handily beating the Zacks Consensus Estimate of 62 cents. (Read More: Caterpillar Tops Q1 Earnings & Revenues, Raises View)

Deere’s second-quarter fiscal 2017 earnings surged around 59.6% year over year to $2.49 per share. Earnings also beat the Zacks Consensus Estimate of $1.70 by a wide margin. Moreover, its revenues of $7.260 billion surpassed the Zacks Consensus Estimate of $7.244 billion. (Read More: Deere Beats on Q2 Earnings & Revenues, Raises FY17 View)

Considering a more comprehensive earnings history, both Caterpillar and Deere delivered positive surprises in each of the prior four quarters. However, Deere stands out with an average positive earnings surprise of 70.4%, better than Caterpillar’s average beat of 40.3%.

When considering Earnings ESP, there is little to choose since both Caterpillar and Deere have an ESP of 0. However, Caterpillar’s earnings estimate for the current year has increased only by 1.4% over the last one month, significantly lower than Deere’s jump of 30.4%.

Conclusion

Our comparative analysis shows that Caterpillar holds an edge over Deere when considering profitability and valuation ratios. Also, Caterpillar offers a stronger dividend yield than Deere.

However, when considering price performance, inventory turnover, average positive earnings surprise and a more comprehensive look at its previous earnings performance, Deere is clearly a better stock. Since there is little to choose between the two, both these Zacks Rank #1 stocks would make great additions to your portfolio.

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