Caterpillar (CAT) is trading just slightly above it’s 52-week low based on our November 30, 2012 watch list (found here). While fundamentals are critical to the assessment of a company's staying power, another tool we find extremely useful is technical analysis.
The chart below shows CAT trading in a downward trend for about 5-6 months. The stock hit a high of $115 in late February then dropped to as low as $79 in mid July. Since then, a bottom was formed in the stock and higher volatility pushed the stock to $93, however, CAT failed to close and stay above the trend line (blue). The higher-lows (red line) that were recently created in July 2012 provides us with clear view on what the defined downside risk might be.
The pattern we’ve identified here is the falling wedge pattern which often indicates a possible reversal in the price. With the stock trading 8.5x forward earning and dividend yield of 2.3%, one could get behind the stock if CAT's price can decisively close above the blue declining trend line. Alternatively, if the stock breaks below the red trend line, the pattern would be deemed broken and more downside should be expected. More often than not, we’ve noticed that this reversal pattern has turned out to be a great risk/reward trade with proper execution.
Again, we'd like to put emphasis on the view that fundamentals tells us what to buy and technical could provide additional information on when to buy.