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Caterpillar Stock Will Struggle Amid Challenges on Two Fronts

The recent selloff of stocks did not spare Caterpillar (NYSE:CAT). Early this fall, CAT stock appeared to have recovered most of its losses that stemmed from the U.S.-China trade war. As late as early October, the Caterpillar stock quote was about $158 per share. That was only about 10% below the stock’s pre-trade war levels.

However, the market’s retreat in October, along with fears of a slowdown, sent CAT reeling. Today, CAT trades at about $121 per share, nearly 24% below its October highs. Now, with factors aside from China weighing on Caterpillar stock, investors should refrain from buying CAT.

CAT Stock Has Been Weighed Down by Oil Woes

To be sure, one cannot overestimate the importance of Asia to Caterpillar stock. Many investors view the 21st century as the “Century of China.” So of course, a trade war involving the People’s Republic will drag one of the highest-profile construction stocks downward.

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However, investors often forget the importance of the oil industry to CAT stock. In the third quarter, the company’s Energy and Transportation division accounted for $5.56 billion of CAT’s $13.5 billion of quarterly revenue. That’s only slightly below the $5.68 billion of revenue that the company’s Construction Industries division generated in Q3.

As a result, CAT depends heavily on oil exploration equipment makers, including Halliburton (NYSE:HAL) and Transocean (NYSE:RIG), for revenue. Caterpillar stock fell by about one-third during the 2014-2016 oil price slump. Now, with oil prices again falling below $50 per barrel, fears of a downturn in drilling have weighed on Caterpillar stock in recent weeks.

Caterpillar Stock Needs a Catalyst

The oil price slump has changed my view on Caterpillar since I last wrote about CAT, but I still see reasons why long-term investors should buy CAT stock. Caterpillar stock trades at a forward price-earnings ratio of just 9.5. It has risen from similar multiples before, and history should repeat itself at some point. Also, its $3.44 per share annual dividend was last cut in 2005, and it has risen in most years since then. So far, I don’t see any factors that would cause the company to lower the dividend of CAT stock anytime soon.

However, as attractive as those metrics may appear, they won’t boost CAT stock much if a positive catalyst doesn’t emerge. With oil now trading below $50 per barrel, one of the major incentives to buy Caterpillar stock has disappeared.

Also, the trade war could cause Caterpillar stock to lose business to Japan-based Komatsu (OTCMKTS:KMTUY), one of CAT’s few competitors. Moreover, even if the trade war ends, many fear that China’s long-anticipated slowdown may finally come to pass. All of these factors will reduce the need for Caterpillar’s equipment.

So where will Caterpillar stock go next? The stock plunged as low as $112.06 per share in late October and then recovered. While the equity has struggled in recent weeks, it has yet to fall back to the $112 per share range. I think a decline to around that level could be a buy signal. However, a plunge below that floor will suggest that the weakness of Caterpillar stock will linger for some time to come. Either way, CAT stock is likely poised for stagnation or worse unless oil prices recover or the trade war ends.

The Bottom Line on Caterpillar Stock

Investors should hold off on buying CAT stock as the company deals with both a trade war and a potential slowdown of the oil and gas industry. Since CAT stock has a low price-earnings ratio and a dividend that’s poised to continue rising, long-term investors who have already bought the shares should hold onto them.

However, for now, CAT stock faces serious near-term challenges. With slowdowns poised to hit its two largest divisions, Caterpillar will struggle to meet its short-term growth targets. Until the trade war ends or oil prices recover, investors shouldn’t buy CAT.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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