Caterpillar's Q4 Earnings Rebound Amid AI Demand, But Tariff Squeeze Validates Caution

What happened

Caterpillar reported Q4 2025 EPS growth, breaking a five-quarter decline streak, driven by surging Power & Energy sales from data-center prime-power orders linked to AI infrastructure. However, margins faced sharp compression due to tariffs and rising manufacturing costs, with management guiding a $2.6B incremental tariff headwind for 2026. The company's record backlog of $51.2B provides long-term visibility, but only 62% is expected to deliver within 12 months, and $19.3B won't be filled in 2026, signaling extended cycle risks. Despite the earnings beat, adjusted operating margin fell to 15.6% in Q4 from 18.3% a year ago, underscoring profitability pressures that could offset revenue gains. Investors must scrutinize whether near-term growth can sustain against persistent cost challenges and a demanding valuation.

Implication

The Q4 results confirm Caterpillar's role as an AI-infrastructure beneficiary, but margin squeeze from tariffs highlights critical execution risks that the market may be overlooking. With a guided $2.6B tariff impact for 2026, management's ability to mitigate costs through pricing and localization will be pivotal for profit recovery. Backlog conversion is a key vulnerability, as only 62% is slated for near-term delivery, increasing exposure to cancellations and delays in a capacity-constrained environment. Valuation at 41.1x P/E is stretched, pricing in flawless execution on both tariff relief and backlog conversion, leaving minimal room for error. Therefore, adhering to the DeepValue report's WAIT rating is prudent, with focus on monitoring 1Q26 tariff run-rate and backlog updates for clearer entry signals.

Thesis delta

The new article reinforces the DeepValue thesis that Caterpillar's earnings growth is tempered by significant cost pressures, particularly from tariffs. No material shift is indicated; investors should continue to await evidence of tariff mitigation and improved backlog conversion in the coming quarters before reconsidering the investment case.