We recently published a list of Dobermans of the Dow: 10 Stocks to Consider. In this article, we are going to take a look at where Caterpillar Inc. (NYSE:CAT) stands against other Dobermans of the Dow to buy.
The Dobermans of the Dow strategy serves as an alternative to the well-known Dogs of the Dow approach, offering a more selective screening process. While the Dogs of the Dow ranks stocks solely based on dividend yield, the Dobermans method prioritizes high-quality companies trading at attractive valuations. The selection process involves two key steps: first, the 30 stocks in the Dow are ranked by Return on Equity (ROE), with the top 20 retained. Then, these 20 companies are further ranked by Free Cash Flow Yield, narrowing the selection to the final ten stocks, which form the Dobermans portfolio. Historically, a hypothetical portfolio following this approach and rebalanced annually has delivered superior performance compared to the Dow, the broader market, and the Dogs of the Dow strategy, according to a report by Forbes. The report further mentioned that since 2000, this methodology has generated a cumulative return of 810%, more than doubling the long-term performance of these benchmarks.
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The significance of dividend stocks is well established, with extensive research examining their long-term performance. A study by Robert Arnott found that over a period of more than 200 years, ending in 2002, the US stock market delivered an average annualized total return of 7.9%, with dividend reinvestment accounting for 5% of that growth. Beyond enhancing overall returns, dividends also provide a buffer during market downturns. Various studies have shown that companies paying dividends tend to experience lower downside risk and recover losses more quickly, ultimately leading to higher risk-adjusted returns over extended investment periods.
Within dividend investing, companies with a consistent track record of dividend growth tend to attract greater investor interest. A report by S&P Dow Jones Indices highlighted that firms with ample cash reserves are better positioned to sustain and expand their operations while continuing to pay stable or increasing dividends. To assess the sustainability of dividends, companies must evaluate whether their payouts are supported by cash generated from operating activities and the availability of free cash flow. Free cash flow is calculated by subtracting capital expenditures—such as spending on property, plants, and equipment (PP&E)—from cash flow generated through operations. Excess cash can be allocated toward dividends, debt reduction, share buybacks, or business expansion.
A positive or growing free cash flow often signals stable or increasing profitability. Since strong free cash flow may indicate a healthy balance sheet, S&P Dow Jones conducted an analysis to determine whether free cash flow yield—measured as annual free cash flow per share divided by stock price—provides valuable insights into investment returns. The underlying investment thesis suggested that all else being equal, companies with a higher free cash flow yield are preferable, as they generate greater free cash income for each dollar invested.
An analysis of the broader market universe, divided into quintiles based on free cash flow yield, revealed that the top-quintile stocks delivered an annualized return of 15.7% between December 1990 and June 2017. This performance exceeded the returns of all other quintiles and outpaced the broader market by an average of 3.6%. While the bottom two quintiles also achieved respectable returns of 11.0% and 8.6% annually, respectively, both underperformed relative to the overall equity market.
Our Methodology
For this article, we filtered the Dow stocks by Return on Equity, narrowing the list to the top 20. These are then ranked by Free Cash Flow Yield, with the top 10 earning the title “Dobermans of the Dow.” The stocks are ranked according to their free cash flow yield. In cases where multiple stocks had the same free cash flow yield, the number of hedge fund investors was used as a deciding factor. Data on hedge funds was sourced from Insider Monkey’s database, which tracks over 1,000 hedge funds as of Q4 2024.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 373.4% since May 2014, beating its benchmark by 218 percentage points (see more details here).
A construction crew operating a hydraulic shovel during a nighttime project.
Caterpillar Inc. (NYSE:CAT)
Free Cash Flow Yield: 0.05
Number of Hedge Fund Holders: 62
Caterpillar Inc. (NYSE:CAT) is an American manufacturing company that specializes in construction, mining, and other engineering equipment. Building on its long-standing tradition of innovation, the company has intensified efforts to integrate advanced technology and digital connectivity across its product lineup. Its strategy to expand autonomous solutions, electrified powertrains, and AI-driven capabilities has contributed to business diversification.
In the fourth quarter of 2024, Caterpillar Inc. (NYSE:CAT) reported revenue of $16.2 billion, reflecting a 5% year-over-year decline. The decrease was primarily due to an $859 million drop in sales volume, driven by shifts in dealer inventories and lower equipment sales to end users. Dealer inventory levels declined by $1.3 billion during the quarter, a sharper reduction compared to the $900 million decrease recorded in the fourth quarter of 2023. Despite the revenue dip, profit per share increased to $5.78, up from $5.28 in the same period the previous year.
Caterpillar Inc. (NYSE:CAT) offers a quarterly dividend of $1.41 per share and has a dividend yield of 1.63%, as recorded on March 10. The company maintained a strong financial position in 2024, generating $12.0 billion in operating cash flow over the year and closing the fourth quarter with $6.9 billion in cash. Throughout the year, the company allocated $7.7 billion to share repurchases and distributed $2.6 billion in dividends to shareholders. This strong cash position has enabled the company to raise its payouts for 30 consecutive years.
Overall, CAT ranks 6th on our list of Dobermans of the Dow to buy. While we acknowledge the potential for CAT as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than CAT but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.
