Investor Optimism Abounds Caterpillar Inc. (NYSE:CAT) But Growth Is Lacking

It's not a stretch to say that Caterpillar Inc.'s (NYSE:CAT) price-to-earnings (or "P/E") ratio of 16x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 17x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Caterpillar has been doing quite well of late. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

View our latest analysis for Caterpillar

Keen to find out how analysts think Caterpillar's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The P/E?

The only time you'd be comfortable seeing a P/E like Caterpillar's is when the company's growth is tracking the market closely.

Taking a look back first, we see that the company grew earnings per share by an impressive 28% last year. The strong recent performance means it was also able to grow EPS by 195% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.2% per annum over the next three years. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader market.

In light of this, it's curious that Caterpillar's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Caterpillar currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with Caterpillar.

If you're unsure about the strength of Caterpillar's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.