Potential long-term growth makes Caterpillar smart buy

Caterpillar (NYSE: CAT), recently trading near its 52-week low, offers an opportunity to buy in at a good price and await the global economic recovery that will boost its stock price.

The company sports an extensive national dealer network and a widespread reputation for high quality. Its service network has allowed its market share to expand and keep customers coming back. It also enjoys a huge name-brand advantage, along with the sheer size of its company in an industry where both play a large role in success.

Caterpillar’s short-term performance may be bumpy, but it will benefit from above-average long-term growth in regions such as China, India and Africa. With increased spending on industrialization and infrastructure building, there will be an increased demand for machinery and commodities. Meanwhile, Caterpillar’s 2011 acquisition of Bucyrus, a mining equipment manufacturer, means that almost half its operating profits are now from the mining end market, where demand is expected to grow.

Another thing in Caterpillar’s favor is its ability, so far, to avoid pricing wars with competition. This is evident in its quickest growing market – China – where it battles rival Komatsu for the dominant position.

With its dividend yield recently around 2.5 percent and its forward P/E ratio in the single digits, Caterpillar deserves some consideration for your portfolio.

Ask the Fool

Q: Are companies with low profit margins bad investments? – R.W., Escondido, Calif.

A: High margins are generally preferable, of course. They can reflect some competitive advantages, such as a strong brand that commands a higher price. Amid a price war, companies with higher margins have more wiggle room. Still, you shouldn’t necessarily avoid lower-margin businesses.

Some industries, such as software, typically have high profit margins. Discount stores and supermarkets typically have low ones – but if they turn over inventory fast enough, they might still be good investments.

Wal-Mart’s margin, for example, is around 3.6 percent, while Target’s is 4.1 percent. But Wal-Mart’s volume is much higher, generating far more profits.

Q: I placed a buy order for a stock before the market opened. The stock had closed at $82 the previous day, so I bid that. But it opened at $84 and kept rising. What’s the deal? How can a stock open at more than its closing price? – B.N., Pensacola, Fla.

A: Demand can build up for a stock overnight, due to a positive news report or some other reason. This will have buyers willing to pay more for it and sellers thus selling it for more.

At any given moment, a stock’s price reflects the last price at which someone was willing to buy it and someone was willing to sell it.

My dumbest investment

One of the first investment moves I made was buying AIG when it crashed. I knew nothing (relatively speaking) about AIG or the stock market, but thought this would be a good chance to profit from panic. I did not profit. I’m thankful that it was a small amount of money lost in exchange for a very valuable lesson. That transaction forced me to become a more informed investor.

Last year I shorted (bet against) shares of Alcoa and that investment is still on the books at a loss. Dumb move, but a smart lesson. Turns out I have neither the time nor knowledge to be a short-term trader. – D.M.G., online

The Fool responds: It sometimes takes a loss to teach us important lessons. Investors can profit by shorting, but it isn’t easy, and you have the company’s management and the global economy working against you. Companies that crash as AIG did can indeed be bargains, but sometimes they just keep falling and other times they require lots of patience. AIG remains well below its pre-crash levels, but it has risen in recent months.