Caterpillar's Q4 Earnings Decline Confirms Margin Squeeze and Challenges AI Growth Narrative

What happened

Caterpillar is poised to report a sixth straight quarter of declining Q4 earnings, driven by weaker pricing and higher costs despite higher volumes, highlighting ongoing profitability pressures. This aligns with DeepValue's findings of margin compression, with adjusted operating margins falling to 17.5% in Q3 2025 under $1.6-1.75B in annual tariffs, well below the 20.7% peak in 2024. While AI-driven data-center power demand has fueled record backlog and Energy & Transportation growth, it hasn't fully offset cyclical softness in Construction and Resource segments or rising dealer inventories. At a P/E of 32x, the stock prices in a seamless secular shift, but filings guide to slightly lower 2025 sales and margins at the low end of the 16-20% target range, exposing valuation risk. Investors now face a high-stakes bet on tariff relief and backlog conversion, with limited upside and potential de-rating if earnings underdeliver.

Implication

The Q4 earnings decline underscores Caterpillar's inability to fully pass on tariff costs, threatening margin recovery and challenging the 32x P/E multiple that assumes sustained AI-driven growth. With adjusted operating margins compressed near 16% and guidance for lower 2025 sales, the cyclical construction and resource segments remain a drag, while dealer inventory build signals channel risk. AI-related Energy & Transportation growth provides a partial offset but relies on converting a record backlog amid supply-chain bottlenecks and 107-week lead times, adding execution uncertainty. Any shortfall in backlog conversion or tariff mitigation could trigger a sharp de-rating, aligning with DeepValue's bear scenario of $480, making new positions unattractive. Therefore, maintaining a 'POTENTIAL SELL' stance is warranted, with re-assessment after Q4 results and 2026 guidance on margins and backlog trends.

Thesis delta

The Q4 earnings news reinforces DeepValue's existing 'POTENTIAL SELL' thesis by confirming ongoing margin pressure and earnings decline, which exacerbate valuation concerns amid high multiples. No major shift is needed, but it heightens the urgency of monitoring margin trends and backlog conversion, as persistent weakness could downgrade the call to 'STRONG SELL' if 2026 guidance keeps margins at or below 16%.