(MENAFN- ValueWalk) Caterpillar (CAT) has a lot more long-term upside potential, but we sold 100% of our Caterpillar shares this morning for a gain of +110% after owning them for 19 months. Before describing the 5 better income-producing investments, we review why we sold our shares of Caterpillar. Our 5 better options than Caterpillar for income-seeking investors are organized from least to most risky, but they're all attractive, in our view. Keep in mind, this article is about attractive income opportunities, but not necessarily the highest income opportunities. As we've written in the past, we loathe 'yield chasing,' and it's one of our .
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Why We Sold CaterpillarWe sold our shares of Caterpillar because its valuation has been driven too high. Specifically, a lot of the optimism surrounding the 'Trump Rally's' economic growth and tax reform expectations (possible overseas cash repatriation, lower corporate tax rates, protectionism in general) are already baked into the price. Caterpillar is no longer a 'Dog of the Dow,' it has the highest short interest of any Dow component, the upcoming upgrade cycle will only go so far, and we've held it over a year allowing us to recognize the lower long-term capital gain rate. For your reference, you can read an excerpt from our original members-only buy thesis report on January 8, 2016, here:
And you can also read our earlier public write up on Caterpillar here:
Simply put, we believe Caterpillar is one of the great American industrial companies, but its valuation has gotten too far ahead of itself given the risks such as valuation, tax irregularities (the IRS executed a search warrant in March over tax irregularities), overseas competition (e.g. Kamatsu), stagnant commodity prices, and currency realities (the marginal benefits of this year's weaker dollar are priced in), and its relatively high cost of capital.
For a little more color on valuation, here is a look at Caterpillar's lofty EV to EBITDA ratio.
And Caterpillar's declining margins.
And here is the big (price-driven) decline in Caterpillar's dividend yield.
We suspect Caterpillar has significant very long-term price appreciation potential, but the price is ahead of itself. Given our +110% 19-month total return, and the fact that the dividend yield was nearl 5% when we bought it and it's under 2.5% now, we freeing up this cash to move it to other opportunities that are more attractive for us.
5 Better Options for Income SeekersOur 5 better options than Caterpillar for income-seeking investors are organized from least to most risky, but they're all attractive, in our view. Without further ado, here is the list.
1. Verizon (VZ), Yield: 4.8%Unlike Caterpillar, Verizon is a Dog of the Dow based on its current yield. If you don't know, the 'Dogs of the Dow' strategy proposes that an investor annually select for investment the ten Dow Jones Industrial Average (DJIA) stocks whose dividend is the highest fraction of their price. Here is a look at the current components of the Dow sorted by dividend yield.
The Dogs of the Dow is a contrarian strategy whereby investors choose companies that are often out favor, and as you saw in the above table, Verizon's stock has delivered negative returns over the last year whereas the overall Dow Jones Industrials Average has been positive. Granted the Dogs of the Dow strategy is passive in nature considering it can be implemented without looking much further than dividend yields (proponents of the strategy argue that blue-chip companies don't alter their dividend to reflect trading conditions and, therefore, the dividend is a measure of the average worth of the company). However, it worth considering a few of Verizon's 'fundamentals.'
For starters, Verizon is the nation's largest network, it generates lots of free cash flow, and despite growing competition (as competitor networks catch up in quality, and compete more on price) Verizon is not going away. Communications networks are the lifeblood of businesses and retail consumers, and with the ever expanding sophistication and demands of network users, especially the eventual arrival of 5G, Verizon's importance will remain strong considering its vast network and economies of scale. Further still, many of the weaker communications company's (e.g. Frontier, CenturyLink, Windstream) may eventually go the way of the dodo bird thereby creating opportunities to pick up marginal customers and marginal assets at fire sale prices.
Further still, in addition to executing on the fundamentals, Verizon is taking steps to evolve for the future.
Another thing to consider about Verizon, simply from an investment allocation standpoint is that it is a 'large value' stock, a category that has been underperforming 'large growth' stocks lately, as shown in the following table.
However, over the long-term, value stocks tend to outperform growth stocks, and this phenomenon will eventually resume, in our view. No one knows exactly when, but large value stocks will eventually overtake large growth stocks, and now is a particularly attractive time to consider large value stocks from a contrarian standpoint.
We've written detailed many times in the past; and based on its current price and dividend safety, Verizon is worth considering if you are a lower-risk income-seeking investor.
2. Kimberly Clark (KMB), Yield: 3.3%Kimberly Clark is not a Dog of the Dow (it's not a member of the Dow) but it is similar in the sense that it is a steady blue chip company with a relatively attractive dividend yield and it's trading at an attractive contrarian price, in our view.
A lot of you may be scoffing that we'd even consider purchasing a boring 'paper-making' company like Kimberly Clark, but our thesis is clear. This profitable business is NOT going away, the price is cheap, and the dividend is big, growing and safe. Here is a look at some of this company's products
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