shaunl/E+ via Getty Images

shaunl/E+ via Getty Images

Today, I'm taking a revised look at Caterpillar Inc. (NYSE:CAT ), following my previous article about the company. As a recap, let me remind you that in that article, I had concluded that Caterpillar's stock was more likely to bounce between the $200 and $220 price mark, following a side movement, due to a variety of reasons. Looking back, it seems that my assessment was correct and my "Hold" designation was confirmed, as the stock moved in line with the S&P 500, providing its shareholders with a total return of 6.7%, since last June.

In this article, I will update the reasons why I believe that this stock has the potential to provide investors with a safer sanctuary for their funds and also why I believe that, if they're looking for exceptional returns, they should look elsewhere.

As I have written in the past, central banks know how to fight inflation in order to cool off a heating economy. This assumption includes the notion of a high rate of economic growth. However, things change when economic growth prospects are mediocre. Due to its conflicting nature, historically, stagflation has been a pain in the neck for governments and central banks. One thing is for sure, though: An increasing number of financial stakeholders and policy makers are arriving to the conclusion that inflation is here to stay for a while. And, in my opinion, the reason why the FED hasn't (yet) announced larger interest rate increases is pure politics. That's because - guess what - it's bad for your portfolio. When Mohamed El-Erian goes out in public and says that investors should reduce their exposure to stocks, to me, that's a red flag.

Still, stocks are the first thing that appeals to retail investors, and its hugeness as an asset class makes it difficult not to find a stock for every situation. The question I'm going to answer here is this: Is Caterpillar a stock to own in this macroeconomic environment?

The answer lies in history. During the stagflation observed in the 1970s, the sharp tightening of the monetary policy along with austerity measures amplified the extent of the recession that followed. In addition, high inflation rates persisted for the years to come. The simple explanation for this phenomenon is that the inflationary pressures were externally caused, due to high oil prices. The same is true today, as U.S. Brent oil price hit $114 per barrel yesterday. One of the most powerful weapons against stagflation is the increase of public spending towards infrastructure. Such a policy has the potential to support employment and boost economic growth, with limited support to inflationary pressures, which, again, are externally caused. At the very least, it has the potential to remove the "stag" part and then battle the "flation" part. At the very best, employment support will not boost inflation further, as households will eventually use their cash to pay down debt, instead of increasing consumption. This could be further ensured by an increase in taxation. But, enough with the economics class. Let's look into Caterpillar, using the context outlined above.

It is obvious that the company will be benefited by such a policy. As a matter of fact, it already has, and this is reflected in its share price. From a valuation perspective, Caterpillar is currently trading at 18.57 times its forward earnings - not quite cheap for the current environment. However, the company expects its forward revenues to increase by 15% and their EPS by 30%, significantly more than the 17% 5 - year CAGR.

Despite the main reason outlined above, there is a bonus reason that will cause Caterpillar to benefit from the current macroeconomic environment. Its name is "commodity price increases."

Historical commodity returns (Visual Capitalist)

Historical commodity returns (Visual Capitalist)

This beautiful table rings a chemistry bell, but its purpose right now is to illustrate the magnificent returns that commodities had during the last year. This is due to various reasons that lie beyond the scope of this article. What I want to underline though, is the result from such price movements: It's literally Christmas for miners and millers. And unlike ship owners, who have to wait months or years to get their newly ordered ship, miners usually tend to replace their machinery in times when their cash flow can support such investments. In addition, given that this is a worldwide trend, it is particularly important to mention that Caterpillar's revenue generation sources are very well diversified across the globe. In that sense, some nice revenue increases may be on the carts during 2022. Adding to this argument, recently Jefferies upgraded the company, naming it a hedge against commodity inflation.

I'm going to be more conservative than Jefferies and sustain my Hold rating for the company. It is a brilliant hedge against inflation, but the current price has incorporated a large chunk of the anticipated positive developments. Still, at the current price level, the company offers a dividend yield of 2%, which is not stellar, but it is sustainable and can provide long-term investors with a nice cushion. I believe that governments will try to support their economies by investing more in infrastructure projects, although not to the expense of their balance of payments.

This policy mix has the potential to boost Caterpillar's revenues. Investors looking for a relatively safe shelter could consider an investment in Caterpillar. Others, who have higher risk appetite, should look elsewhere.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written for information purposes only. You should not, in any case, take the contents of this article to be an urge to buy, hold or sell securities. Always perform your own research before investing in the stock market.