Caterpillar Beats Earnings, Stock Gets Pummeled. Why?

Blowout Quarter

On Tuesday before the markets opened, Caterpillar (CAT) reported record Q1 sales and earnings and raised guidance for the rest of 2018 by almost 25%. The stock immediately rallied nearly 5% to $161.10 in the pre-market session as investors digested the seemingly flawless earnings release.

Revenues for the quarter were $12.9B, 31% higher than Q1 2017 and handily beating the Zacks consensus estimate of $11.58B. Net earnings on a non-adjusted basis were $2.74/share, blowing away the consensus estimate of $2.11/Share. (Earnings adjusted for non-recurring restructuring costs were even slightly higher still at $2.82/share.)

The company was a beneficiary of 2018 U.S. tax reform, estimating an effective rate of 24% for the quarter versus 32% in Q1 2017.

Caterpillar raised guidance for 2018 a whopping 2 dollars to a range of $9.75 - $10.25/share from the previous range of $7.75 – $8.25/share. They cited continuing strong demand in each of the core industries they sell equipment to with Mining, Oil and Gas, Construction and Infrastructure all experiencing boom times. Sales increased across all regions.

Even the parts of the release that were supposed to be cautionary were generic boilerplate about “economic conditions” and unpredictable Pension costs. Hardly anything to be worried about.

By the end of the trading day Caterpillar stock was closing at $144.44, down over 6% for the session.

Why?

The TV talking Heads mostly pointed to a single comment from Caterpillar’s 10am conference call when CFO Brad Halverson said that Q1 earnings probably represented a “High Water Mark” for 2018, apparently suggesting that the quarter was so perfect, they were unlikely to beat it during any of the next three. Citing margin pressures due to higher materials costs, even the rosy sales outlook was unlikely to produce another blowout quarter.

Then there was the fact that the yield on 10-year treasury bonds traded above 3% this morning for the first time in over 4 years, making equity investors nervous about inflation fears and slowing growth.

Finally, there was a joint press conference between President Trump and President Emmanuel Macron of France in which they alluded to their private discussions about North Korea, Syria, and Iran, but said little of substance about any of those situations that the markets could embrace as progress.

Rationally, the “High Water” comment shouldn’t have come as a surprise, at least to anyone who owns a calculator. Caterpillar raised full-year guidance to a range of $9.75- $10.25 while reporting $2.82 in Q1. If they hit even the high end at $10.25, subtracting the $2.82 they’ve already reported, that leaves $7.43. Divide that by 3 (since there are three quarters remaining) and the average is $2.48. Sure it’s less than $2.82, but it’s still higher than even the highest estimates prior to today’s report.

The 3% level in ten-year Treasuries is a psychologically important threshold, but is statistically arbitrary. Does anyone believe corporate profits will be appreciably lower at 3.05% than at 2.95%? Even sophisticated traders and analysts can become fixated on round numbers and lose the forest for the trees.

Finally, the markets may have been disappointed to not get more comfort from the Trump – Macron conference, but the world is certainly no more uncertain today than it was yesterday. Unless the markets were pricing in complete resolution of all geopolitical risk, it’s hardly justification for taking the Dow Jones Industrial Average down 600 points (as it was at one point this afternoon before recovering slightly.)

So what’s an investor to do on a day like today when nothing seems to make sense? Keep your head up. Understand the fundamental strengths and weakness of the companies you invest in and only let a change in those fundamentals change your mind. Pay as little attention as possible to herd selling (or herd buying for that matter.) And scoop up companies like Caterpillar when they’re beaten down undeservedly.