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Caterpillar Makes the Case for Going Abroad

Caterpillar proves that diversification reduces risk in bad times and juices returns in good times.

PEORIA, Ill. (TheStreet) -- Caterpillar (CAT) - Get Caterpillar Inc. Report, the construction-equipment company based in America's heartland in Peoria, Ill., crushed first-quarter earnings estimates largely because of foreign demand.

Diversification aided Caterpillar during the past two years as the U.S. economy sank into its deepest recession in 80 years. Now that global economies are growing again, expect orders to accelerate.

The first rule of portfolio management is to diversify. That helps to spread risk around so no single factor determines the success or failure of the whole. That's true also for companies with the opportunity to move into new markets.

The benefits of diversification are all over Caterpillar's first-quarter earnings report. Net income was $233 million after a loss of $112 million a year earlier. Full-year profit will be about $2.50 to $3.25 a share, compared with a January forecast of about $2.50. Caterpillar's stock yesterday jumped 4.2% at the close of New York Stock Exchange trading, the largest increase in more than 10 weeks.

>> Who Owns Caterpillar?: Ken Fisher

Interestingly, Caterpillar projects economic growth for world economies. (Chief Executive Officer Jim Owens has a doctorate in economics.) Caterpillar said the U.S. economy may grow 3.5% this year, while developing nations might expand more than 6%. That's important because two-thirds of the company's revenue comes from abroad. Caterpillar credited improvement in developing economies as a key to its success.

Other industrial companies such as

General Electric

(GE) - Get General Electric Company Report

,

Honeywell

(HON) - Get Honeywell International Inc. Report

,

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Deere

(DE) - Get Deere & Company Report

and

United Technologies

(UTX) - Get United Technologies Corporation Report

also enjoy exposure to international markets, but to varying degrees. GE follows Caterpillar with 54% of its revenue coming from overseas. United Technologies is at 46%, Deere at 35% and Honeywell at 39%.

Those companies' 52-week performances follow the order of their international exposure. Caterpillar has gained 120%, while GE, United Technologies, Honeywell and Deere have risen 64%, 59%, 58% and 57%, respectively. Companies that spread risk across the world have done better during the rally over the past year.

For many of those companies, diversification is a matter of life or death. Growth in the BRICs -- Brazil, Russia, India and China -- is outpacing that of the U.S. Those countries have much more room for growth and a nearly unquenchable thirst for infrastructure improvements and modernization.

Taking full advantage of opportunities in developing markets is crucial for GE and United Technologies. In America, the baseline is much higher than in nearly every part of China or India, countries that need to find ways to feed, power, lodge and employ billions of people. Selling turbines, earth movers, power plants, water-purification systems and other industrial supplies there is much easier than it is in a country with growth in the low single digits and a massive deficit.

Caterpillar is projected by analysts to post revenue growth of 14% this year and next, compared with the less diversified Deere's 8.2% and 8.8%. Look abroad.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.