Aside from being well-known, industry-leading brands, Apple (AAPL -1.22%), Target (TGT 1.03%), and Caterpillar (CAT -0.55%) may not have much in common as companies. But as stocks, all three investment opportunities balance growth, income, and value.
Another throughline is that each business generates a ton of free cash flow (FCF) and then uses that FCF to pay dividends and buy back stock.
Here's how stock buybacks have helped to bolster shareholder value, and why Apple, Target, and Caterpillar are top stocks to buy now.
Image source: Getty Images.
This is how you buy back stock
Apple is the poster child of using the vast majority of its FCF to buy back its own stock. Over the past five years it has bought back 19.5% of its own stock, and nearly 40% over the last 10 years. And it has done so at prices far lower than the current price of the stock. Caterpillar and Target have done similarly timely repurchases, but not to the extent of Apple.
The above chart shows exactly the pattern that investors want to see, which is a rising stock price combined with lower shares outstanding. In other words, the stock buybacks were a good use of capital because the share prices are higher today and the repurchase of stock has boosted earnings per share.
What investors don't want to see is a falling stock price and a high volume of buybacks, because that indicates a company overpaid for its stock and possibly could have put that capital to work more effectively by improving the underlying business.
In the case of Apple, the company pays a small dividend that yields just 0.6%. Apple's FCF yield of 3.9% suggests the company could theoretically have a 3.9% dividend yield if it didn't buy back stock and used all of its FCF on paying dividends instead.
However, long-term investors would likely prefer that Apple uses its FCF on buybacks and not the dividend because buybacks permanently reduce the outstanding share count and lead to a better value for Apple stock over the long term.
A rock-solid dividend yield backed by a great brand
Like Apple, Target has done a phenomenal job of buying back shares at a lower average price than the current price of the stock. But Target simply doesn't have the growth prospects or high margins that Apple enjoys. And for that reason, it makes sense for Target to do a combination of buying back stock and paying a high dividend -- which is exactly what Target is doing.
Not only does Target stock have a dividend yield of 2.7%, but it is also a Dividend King, meaning an S&P 500 component that has paid and raised its dividend for at least 50 years.
Target's track record for dividend raises and stock buybacks indicates that it is a stable business that routinely generates more FCF than it needs, and it directly passes that FCF along to shareholders.
Even so, Target hasn't shied away from growth opportunities. It wasn't long ago that investors talked about Amazon (NASDAQ: AMZN) and the rise of e-commerce inflicting permanent or even existential damage on Target's business model. To its credit, Target invested in e-commerce and curbside pickup. But it did so in a way that was conducive to its business model -- which was essentially leveraging its stores to serve as pickup locations and save on shipping.
That strategy has proven highly successful for Target. It has been able to boost its top and bottom lines without directly competing with Amazon by shipping from a warehouse to a consumer's doorstep. In fact, Target said that more than 95% of sales, including its digital sales, were fulfilled by its stores in 2022. Target has done an excellent job of leveraging its existing business model to adapt to modern consumer needs instead of trying to reinvent the wheel and play catchup with Amazon.
A cyclical business model, but a reliable and safe stock
Caterpillar stock has arguably been undervalued for a long time. The true value of the company's global oil and gas, construction, and mining portfolio has been put on display during the supply chain challenges over the last couple of years. Caterpillar stock reached an all-time high in January. Since then the stock has fallen about 20% from that peak. But the company's slew of buybacks over the past five years still looks prudent in hindsight.
What's more, Caterpillar has a 2.2% dividend yield and has paid and raised its dividend for 29 consecutive years -- a rare feat for a cyclical company that is heavily dependent on the broader economy.
Caterpillar's diverse business model, both across industries and geographies, as well as its high FCF, dividend, and ability to buy back shares make it a unique industrial stock. The company benefits from economic tailwinds while avoiding catastrophic downturns in its business when the economic cycle shifts. Caterpillar is a great stock to own for long-term investors that want to benefit from global industrialization without the volatility in earnings that is so common among smaller, less diversified industrial names.
A mixed trio of great buys now
Apple, Target, and Caterpillar all tend to generate high amounts of FCF and use that FCF to directly benefit shareholders. Apple leans more on buybacks than dividends, believing its ability to grow earnings will reward long-term shareholders more than a dividend. Meanwhile, Target and Caterpillar blend a combination of dividend raises and buybacks, and both sport impressive steaks of dividend raises year after year.
Investors looking to build a diversified portfolio could consider investing in all three industry-leading businesses for exposure to different sectors of the economy and a blend of growth, value, and income.
