Contrarian investors favor unloved but promising stocks. Caterpillar (CAT) easily fulfills the first criterion. Its stock has lost just over half its value in a year, underperforming a dismal broad market by 12 percentage points. It fetches just six times this year's earnings forecast, less than half the market's price. A generous 4.8% dividend yield has lured few buyers.

Put into perspective, today's stock price is the same one Caterpillar carried five years ago. Sales since then have well more than doubled. Per-share profit has nearly doubled. Caterpillar isn't just priced as though the world-wide construction boom of recent years has fizzled. It's priced as though it never happened.

Judging whether shares are promising at today's modest price is a trickier matter. Rich countries are in recession. The economies of North America, Europe and Japan are expected to grow by less than 1% next year, and that forecast is starting to look optimistic. America's economy shrank by 0.3% in the third quarter, the Commerce Department reported Thursday. That bodes poorly for purchases of construction and earth-moving equipment, of which Caterpillar is the world's largest maker. Developing economies are expected to grow by 5% or so next year. Caterpillar sees emerging-market sales growth offsetting "sharp declines" in rich countries, leaving overall 2009 sales "about the same" as in 2008.

Profit is likely to fall, though. Used equipment prices have weakened, putting pressure on new machines. A rise in the dollar and in machine financing rates makes equipment purchases more expensive for many buyers, unless both are offset with discounts. Caterpillar says dealers hold "appropriate" inventory levels. If it is wrong, expect prices to fall. Falling commodity prices might ease production costs in coming quarters, but will likely ease demand for mining machines, too.

Credit losses could sting as well. Like most companies today that sell big machines, Caterpillar is part bank. Last year financial services brought in 7% of sales. In the third quarter bad debt write-offs totaled $22 million, up from $15 million a year earlier. Past-due receivables rose to 3.6% from 2.4% (still short of the 4.8% they peaked at in early 2002).

Caterpillar isn't giving specific sales and profit forecasts for 2009 until January. Analyst estimates are scattered. The average of 22 outlooks is for sales to drop 2% and per-share profits 13%. The grimmest has profits falling 43% from this year's consensus.

Long-term investors can look to promising signs, though. A machine shortage in recent years means miners, drillers and builders have run gear ragged. Caterpillar figures that half of coal and metals equipment is more than 10 years old. That should keep parts sales and repairs brisk until new machine orders pick up. Caterpillar is also in the middle of shifting to a Toyota-style system of lean manufacturing. Analysts say the potential for long-term cost savings easily outweighs the upfront costs.

All told, a purchase of Caterpillar at the brink of what looks like a world-wide economic slowdown might be just the thing for contrarian investors. The stock price already reflects plenty of pessimism. In a worse-than-feared recession, dividends will at least soften price declines. In a surprise recovery, Caterpillar should be among the first to prosper.

Caterpillar turned up in a recent search for stocks that have been pummeled worse than most over the past six months and now look underpriced. Have a look at all six screen survivors if you like. To run the search for yourself, use SmartMoney's stock screener and the full list of criteria.

Contrarian Screen Recipe
26-week price change below industry median
1-week price change positive
Forward P/E below industry median
Price/free-cash-flow ratio below 20
Dividend yield greater than 3%