Large-cap companies such as Caterpillar Inc (NYSE:CAT), with a market-capitalization of $92.66B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in CAT is its financial health. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. These factors make a basic understanding of a company’s financial position of utmost importance for a new investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Check out our latest analysis for Caterpillar
Does CAT face the risk of succumbing to its debt-load?
Debt-to-equity ratio standards differ between industries, as some some are more capital-intensive than others, meaning they need more capital to carry out core operations. Generally, large-cap stocks are considered financially healthy if its ratio is below 40%. In the case of CAT, the debt-to-equity ratio is over 100%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. CAT’s interest on debt is sufficiently covered by earnings as it sits at around 9.22x. Debtors may be willing to loan the company more money, giving CAT ample headroom to grow its debt facilities.
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A basic way to evaluate CAT’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses CAT’s debt repayment capacity, which is not a big concern for a large company. CAT’s recent operating cash flow was 0.19 times its debt within the past year. A ratio of over 0.1x shows that CAT is generating adequate cash from its core business, which should increase its potential to pay back near-term debt.
Are you a shareholder? With a high level of debt on its balance sheet, CAT could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case so investors should ask themselves if they believe CAT can sustainably increase its operational efficiency going forward. Given that CAT’s financial position may differ over time, I recommend examining market expectations for CAT’s future growth on our free analysis platform.
Are you a potential investor? While investors should analyse the serviceability of debt, it shouldn’t be viewed in isolation of other factors. After all, debt financing is an important source of funding for companies seeking to grow through new projects and investments. This is why I recommend potential investors to assess CAT’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
This news has been published by title Caterpillar Inc (NYSE:CAT): Time For A Financial Health Check
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