When this key number turns around, Caterpillar's stock becomes a buy and sell

No one says investing in stocks is easy and that this observation will certainly exist when checking the investment proposition that is being examined. caterpillar (NYSE: Cat) Now. There is a strong case today to buy stocks of heavy machinery manufacturers, but investors will see a key thing before buying stocks.

Despite sales in the first quarter down 10% year-on-year and operating profits down 27%, there are still strong cases of buying caterpillars. It is based on three interconnected factors.

Before supporting these points in detail, it is worth noting that Caterpillar generates the vast majority of sales for end users through independent dealers. Dealers manage their equipment list, and the sales data in the figure below reflect their sales to their end users.

On a first-quarter earnings call in late April, outgoing CEO Jim Umpleby noted: “Machine sales are stronger than expected in the first quarter, resulting in flat machine dealer inventory rather than our expectations for dealer inventory growth this quarter.”

Caterpillar's retail sales to end users in the construction, energy and transportation sectors were in positive growth sectors in the first quarter, with the resource industry (mining and summary) down just 10%, reducing total machine sales (including construction and resource sector sales) to negative regions.

Data source: Caterpillar Demo, Author Chart.

End users’ sales exceeded expectations (remember, they represent dealers’ sales) caused dealers to increase inventory by $100 million in the first quarter. By comparison, dealers increased their inventory by $1.4 billion in the first quarter of 2024.

CEO Joe Creed said that “dealers are ordering supplementation” in light of the current sales model, which provides trust in management’s 2025 graphical sales forecasts.

Overall, management’s full-year guidance (excluding the impact of tariffs) is targeted at steady sales, adjusted operating margins (approximately 16% to 20%) in the first half of its cyclical range, and free cash flow (FCF) to the first half of the $5 billion to $10 billion range.

For reference, Wall Street analysts received $8.4 billion in FCF in 2025, a figure that will bring Caterpillar Stock to 19.6 times the FCF in 2025, a good valuation, a cyclical company. That was a purchase case, very eye-catching.

Field construction worker in background equipment.
Image source: Getty Images.

Having said that, there are several considerations to keep in mind. First, the great unknown about the tax landscape. Management’s comments on the matter include changing the guidance from the “top half” of the scope discussed above to “internal”, assuming tariffs were met in late April. People have been downgrading since then, which gives investors a reason to feel more positive.

The second consideration is more problematic and related to "price realization". This is the impact of the specified price on sales and operating profits, regardless of the impact on sales volume. Positive price realization means that Caterpillar can achieve better prices mechanically and can also reflect relatively better sales for higher prices mechanical or more profitable geographical locations. Negative price realization suggests that Caterpillar may offer discounts or incentives for competition.

Changes in operating profits are almost entirely attributed to changes in sales volumes (the sales volume of Caterpillar, not the sales of the dealers mentioned above) and price realization. As shown in the figure below, the realization of positive prices can offset the decline in sales until the second quarter of 2024, with the two trends falling in the third quarter.

Change operating profits.
Data source: Caterpillar Demo, Author Chart.

Negative prices may continue to be achieved in the second quarter due to a difficult comparison with the second quarter of 2024. However, assuming Caterpillar sales will improve in the second half of the year, this is consistent with the positive trend in user sales and dealer inventory positions. In this case, it is reasonable to expect improvements in price realizations in the third and second quarters.

This is a key metric for viewing, indicating enhanced market conditions and the ability of Caterpillar to grow revenue and achieve its full-year targets.

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Lee Samaha has no position in any of the stocks mentioned. Motley fool has no position in any stock mentioned. Motley Fool has a disclosure policy.

Forecast: When this key number turns, Caterpillar stock was originally published by Motley Fool