A Bad Bet in China

Tyler is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Hindsight is always 20/20. It is often difficult for a company to project future results, just as it is difficult for investors to project how certain moves will affect their investment. Caterpillar (NYSE: CAT) has made some questionable decisions that may not affect investor's as much as it seems.  

Caterpillar actually released a fairly positive report in regards to the fourth quarter - with earnings being better than expected. Although it may not seem like much, shares increased by 2% early Monday morning (last week). Potentially the biggest news for investors looking at Caterpillar right now is the company's net income. Investors were rightfully concerned with Caterpillar's 50% drop in net income due to performance in China. Although management claims they performed their due diligence on the Siwei purchase, it appears the company has a multi-year intentional accounting fraud. It was a good quarter for the company, but not more than half of the acquisition is off the books. 

With approximately 70% of Caterpillar's business being derived internationally, the deal looked more promising before it happened. The company was trying to take advantage of the rising economy in China, however many investors will be questioning Caterpillar's management after letting this acquisition go through. Investors are often hesitant to invest in small-mid cap Chinese companies that appear attractive because they haven't established trust with investors. It is an entirely different situation when a trustworthy company like Caterpillar says they did their due diligence, and still got the short end of the stick. 

Unfortunately, this is the risk of investing in stocks and investors need to understand the importance of diversification among companies, industries, and market caps. Often times investors view acquisitions as an opportunity, yet this is a perfect example as to why acquisitions are generally more of a risk. For nearly five years European investments have been risky, and this was shown when Caterpillar announced expectations of growth in every area except Europe. That shouldn't go without saying that the United States has also been one of the riskiest markets to invest in for the past several years as well. 

It should also be noted that Caterpillar is approximately a $70 billion company and this is only a $580 million write down. So, in the grand scheme of things, it's a drop in the bucket for such a large company, but investors will still wonder what their definition of "due diligence" really is. Investors need to take this as an example and learn that it is long term implications that demand our attention.  Caterpillar will be fine, and won't view this as anything but a speed bump financially. 

Deere and Company (NYSE: DE) is Caterpillar's largest competitor with a market cap of $36.2 billion. Deere's stock has increased nearly 9% in the past three months, and they actually hit an all-time high in late January. In the past decade the company has more than doubled its revenues and more than tripled its stock. The company shows a 2.6% FCF yield compared to Caterpillar's FCF yield of less than .5%. Deere has been in business for over 175 years and currently holds approximately 50% of all North American Farm equipment. Over the past ten years Deere has invested about 4% of its revenues into research and development annually - far more than most of its competitors. 

As with every business there are obstacles for Deere to overcome. The company seems to be struggling in foreign markets as this example highlights. Despite controlling approximately half of the Indian market for tractors greater than 50 horse power, these machines account for less than 10% of the country's market, yet over 50% in North America. To help gain traction internationally, Deere has released new products in Brazil which have performed well. 

The Foolish Conclusion...

Investors can learn a lot from these companies. Europe seems to be very risky at the moment, but Caterpillar should be ok despite its questionable acquisitions. Deere seems to be struggling in India, despite controlling half of the Indian market. Both stocks are performing well, but Deere seems to present a better value than Caterpillar. Whichever company figures out the foreign markets first will likely see more immediate success. 


tlwofford has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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