Value Investing With Blue Chip Stocks


Value investing isn't all about finding low-priced stocks. In the legendary words of Warren Buffett, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

With that proven strategy in mind, let's take a look at today's Dow Jones Industrial Average with an eye for fair or wonderful prices among its 30 proven blue chip businesses. At the very least, using the Dow as our first filter ensures that we're looking at stocks that once passed the index's famously strict criteria for inclusion. Then it's up to the investor to sort the still-healthy wheat in this 30-ticker target list from the fading chaff.

Today, we'll look at a best-in-class business that trades at a totally backwards discount to its chief competitors.

Why am I so cheap?
Caterpillar is the only Dow member from the heavy construction industry. Cat makes the machines that make the world go round, and I think it's fair to say that nobody does it better.

The company works closer to the infrastructure construction market core than anybody I can think of. The economic headwinds of the last five years have made this a brutally inhospitable sector to focus on, and yet Caterpillar keeps pumping out superior returns on invested capital -- a highly Foolish measure of real-world profitability.

CAT Return on Invested Capital Chart
CAT Return on Invested Capital Chart

CAT Return on Invested Capital data by YCharts.

So Caterpillar beats the pants off sector rivals Briggs & Stratton and Terex in terms of efficient operations. The stock must surely trade at a premium to those inferior performers.


As it turns out, Caterpillar shares are orders of magnitude cheaper than Terex or Briggs & Stratton.

CAT PE Ratio TTM Chart
CAT PE Ratio TTM Chart

CAT P/E Ratio TTM data by YCharts.

I suppose you could argue that the two much smaller competitors earn their high valuations by dint of being smaller and nimbler than the giant Caterpillar operation. But then you'd have to expect them to deliver much higher growth than Caterpillar. That's not the case, either.

It's true that Caterpillar's sales growth just about flatlined year-over-year in the latest reported quarter. But Terex didn't do much better with a 2.7% sales bump, and Briggs & Stratton's revenue plunged 13%. Hardly the kind of performance that should earn premium valuations in my book.

I find it hard to argue that Caterpillar's shares don't deserve a richer valuation. Trading at just 0.9 times trailing sales and 11 times earnings, this quality stock is too cheap any way you slice it. Placing it next to richly valued rivals only underscores just how unfairly Caterpillar's shares are priced today.

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Fool contributor Anders Bylund holds no position in any company mentioned. Check out Anders' bio and holdings or follow him on Twitter and Google+.The Motley Fool owns shares of Terex. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Originally published