American Electric Power Company, Inc. (NYSE:AEP) shares are down more than -11.24% this year and recently decreased -0.43% or -$0.28 to settle at $65.30. Caterpillar Inc. (NYSE:CAT), on the other hand, is up 0.30% year to date as of 02/14/2018. It currently trades at $158.06 and has returned 2.41% during the past week.
American Electric Power Company, Inc. (NYSE:AEP) and Caterpillar Inc. (NYSE:CAT) are the two most active stocks in the market based on today’s trading volumes. To determine if one is a better investment than the other, we will compare the two companies’ growth, profitability, risk, return, and valuation characteristics, as well as their analyst ratings and sentiment signals.
One of the key things investors look for in a company is the ability to grow earnings at a high compound rate over time. Analysts expect AEP to grow earnings at a 5.63% annual rate over the next 5 years. Comparatively, CAT is expected to grow at a 19.95% annual rate. All else equal, CAT’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
A high growth rate isn’t necessarily valuable to investors. In fact, companies that overinvest in low return projects just to achieve a high growth rate can actually destroy shareholder value. Profitability and returns are a measure of the quality of a company’s business and its growth opportunities. We’ll use EBITDA margin and Return on Investment (ROI) to measure this., compared to an EBITDA margin of 10.81% for Caterpillar Inc. (CAT). AEP’s ROI is 3.30% while CAT has a ROI of 0.60%. The interpretation is that AEP’s business generates a higher return on investment than CAT’s.
The value of a stock is simply the present value of its future free cash flows. AEP’s free cash flow (“FCF”) per share for the trailing twelve months was -0.38. Comparatively, CAT’s free cash flow per share was -1.04. On a percent-of-sales basis, AEP’s free cash flow was -1.21% while CAT converted -1.36% of its revenues into cash flow. This means that, for a given level of sales, AEP is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Liquidity and leverage ratios are important because they reveal the financial health of a company. AEP has a current ratio of 0.60 compared to 1.40 for CAT. This means that CAT can more easily cover its most immediate liabilities over the next twelve months. AEP’s debt-to-equity ratio is 1.20 versus a D/E of 2.30 for CAT. CAT is therefore the more solvent of the two companies, and has lower financial risk.
AEP trades at a forward P/E of 15.87, a P/B of 1.78, and a P/S of 2.08, compared to a forward P/E of 14.97, a P/B of 6.00, and a P/S of 2.02 for CAT. AEP is the cheaper of the two stocks on book value basis but is expensive in terms of P/E and P/S ratio. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. AEP is currently priced at a -11.76% to its one-year price target of 74.00. Comparatively, CAT is -11.86% relative to its price target of 179.32. This suggests that CAT is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.30 for AEP and 2.40 for CAT, which implies that analysts are more bullish on the outlook for CAT.
Risk and Volatility
Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. AEP has a beta of 0.30 and CAT’s beta is 1.22. AEP’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
Analysts often look at short interest, or the percentage of a company’s float currently being shorted by investors, to aid in their outlook for a particular stock. AEP has a short ratio of 2.21 compared to a short interest of 2.20 for CAT. This implies that the market is currently less bearish on the outlook for CAT.
American Electric Power Company, Inc. (NYSE:AEP) beats Caterpillar Inc. (NYSE:CAT) on a total of 8 of the 14 factors compared between the two stocks. AEP is more profitable, generates a higher return on investment, has higher cash flow per share, has a higher cash conversion rate and has lower financial risk. Finally, CELG has better sentiment signals based on short interest.