Beware of dodgy headlines. Beware of soft estimates.  As earnings season forges onward, nervous investors are latching onto any morsel of good news they can find – even if it’s artificial.

Take Caterpillar (NYSE: CAT), for example. With a history dating back to 1925, the company is now the top manufacturer of construction, mining, and forestry equipment, plus industrial turbines and engines for machinery and power generation systems. Whether it’s construction, agriculture, energy, marine, or infrastructure, Caterpillar’s presence is splashed across several sectors.

It’s no surprise, therefore, that its quarterly numbers are always keenly anticipated and thoroughly scrutinized – not just because it’s one of America’s leading firms, but because it’s also a key indicator of economic health.

And its latest batch of results don’t bode well…

Caterpillar’s Second Quarter Crawl

Back in April, my colleague Karim Rahemtulla noted the importance of Caterpillar’s performance as a barometer for the wider economy.

It came as the company reported its first quarterly earnings loss since 1992, as profits sank by $112 million on a 22% drop in sales.

And the second quarter proved to be a struggle, too…

• Revenue: Plunged by 41% to a shade under $8 billion, led by a 43% drop in equipment and 32% fall in engine sales. It was the third straight month of equipment sales declines. By region, machinery sales tanked by 51% in North America… 61% in Europe… 47% in Latin America… and 25% in Asia-Pacific. Large equipment sales are Caterpillar’s biggest revenue generator.

• Profit: Got whacked by 66% – $371 million (60 cents per share), compared with $1.1 billion ($1.74 per share) in Q2 2008. This was due to falling demand for its products in the midst of a recession, but also from less obvious factors like lower commodities prices (and consequently profits) at some of Caterpillar’s key mining customers.

To see results like this, you’d think the company’s shares would be getting walloped. They’re not. The stock ended today up $2.81 (7.9%). And this month overall, the stock is up 17.9%.

And this highlights another key point: Earnings season is nuts.

Bring Out The Arbitrary Analysts And Fickle Investors

Remember that “artificial” good news I mentioned earlier?

With companies terrified of missing their earnings forecasts and seeing a subsequent stock drop, estimates are generally conservative. Very conservative.

With Caterpillar, for example, the average estimate from Thomson Reuters and Bloomberg analysts was 22 cents per share. The company actually earned 60 cents. Similarly, Caterpillar projects its full-year earnings to slide into a chasm-like range between $1.15 and $2.25 per share. Again, this blows away the $1.01 per share analyst estimates.

Do yourself a favor. Don’t pay any attention to analyst estimates at the moment – they don’t mean diddly. And take earnings reports for what they are – temporary catalysts that often don’t reflect the real story.

In April, Caterpillar CEO Jim Owens cited a “high degree of uncertainty” about the global economy, continuing, “It’s extremely difficult to know how our customers will respond during the remainder of 2009.”

If he doesn’t know, do you really think that analysts have a better idea? Or the investors who merrily pile on after the company beats arbitrary estimates?

Some of Caterpillar’s gains came courtesy of heavy cost-cutting measures (the company has shed 17,100 full-time workers since December and a further 17,000 contract and temporary workers), lower production, and a lower tax rate.

There is a bright side…

The “CAT Scan” Of The Global Economy

Even as the recession squashes demand for its products and a “great deal of economic uncertainty” exists, Caterpillar was able to raise its full-year earnings forecast from $1.15 per share to that range between $1.15 and $2.25.

As Owens states, this was due to “signs of stabilization that we hope will set the foundation for an eventual recovery.” He continued by saying that, “Credit markets have improved significantly. Fiscal policy and monetary stimulus have been introduced around the world, and we are seeing signs, particularly in China, that they are beginning to work.” Owens is complimentary of China’s massive infrastructure spending plan.

An improved global outlook is crucial for Caterpillar, given that about two-thirds of its sales came from outside the U.S. in 2008, according to Bloomberg.

At the moment, however, Caterpillar says the global economy could fall by more than 2% this year, compared with the 1.3% drop it forecast in April. And its predictions aren’t random. Bloomberg says Caterpillar correctly forecasted the U.S. economic recession in October 2007 – two months before it officially began.

The company says the U.S. economy was still in recession at the end of the second quarter and anticipates another decline in the current three-month period before growth picks up towards the end of the year.

This supports the view that while the recession is easing, it’s not yet over. For example, the National Association for Business Economics’ just-released quarterly survey says…

• Companies reporting earnings losses outnumbered those with higher profits for the sixth straight quarter.
• More than two-thirds of the companies said they laid off workers during the second quarter, compared with a measly 6% that added jobs – the lowest in the survey’s 30-year history.
• And Reuters quotes the survey: “Industry demand was still declining in the second quarter of 2009, but the breadth of decline had narrowed considerably since late 2008, raising prospects for stabilization in the second half of the year.”

Time will tell. Just be sure you get the full story beyond the headlines, the analysts’ estimates, and short-lived earnings reports in the meantime.

Source:   Earnings Reports: The Real Deal Behind Wall Street’s “Caterpillar Spin”