Caterpillar Buyback Teases Dividend Issue

Do investors now prefer stock buybacks to big dividends? A steady stream of buyback announcements by companies contrasted with rather skimpy dividend increases suggests that but there’s no clear answer to the question.

Caterpillar Inc. Thursday handled the issue neatly. The maker of construction and earthmoving equipment said it would repurchase up to 10 percent of its shares - and increase its dividend by 40 percent.

Something for everybody and Caterpillar, riding the current economic expansion, has the cash to pull it off.

Since Congress re-established the capital gains tax two years ago, many shareholders would rather have their companies buy back stock than give them a dividend increase. If they sell their shares back to the company at a profit, the gain is taxed at a rate of 28 percent. The tax rate on dividends is as high as 39.6 percent.

Caterpillar said it would buy back up to 20 million of its shares on the market in the next three to five years. Besides returning money to stockholders, buybacks also increase earnings per share and eventually may increase a stock’s price.

The company also raised its quarterly dividend to 35 cents a share from 25 cents. It was the third dividend increase by the Peoria, Illinois-based company in 12 months. In May 1994, the payout was just 7.5 cents.

At current prices, the stock buyback could cost Caterpillar $1.2 billion. Meantime, it will be paying $280 million a year in dividends.

Merrill Lynch & Co. analyst James McCann said he expected both the buyback and dividend increase, though both were bigger than he thought they would be.

Caterpillar can afford to be generous. The company has reported record profits for the last five quarters. In the first quarter of 1995, it earned $300 million, or $1.50 a share, on sales of $3.91 billion.

Chairman Donald V. Fites said Caterpillar’s recent moves to modernize plants, cut costs and move into new markets means the company can continue to succeed “well into the next century.” He probably means for about the next 10 years but “well into the next century” sounds like a lot more.

Caterpillar’s profits undoubtedly will by hampered by the next economic downturn; it’s that kind of company. Caterpillar had operating losses in both 1991 and 1992. A spokesman said, however, that the company believes it can remain profitable in the next downturn.

The company does seem to have learned how to keep all sorts of shareholders happy. Last September it split its stock two-for-one. Big investors with billions to spend couldn’t care less about stock splits. But smaller fry seem to like the lower prices that splits bring.

While Caterpillar finessed the question about buybacks and dividend increases, it remains on the minds of analysts. Some are concerned that the current average dividend yield of 2.51 percent on stocks in the Standard & Poor’s 500 Index indicates stocks are overvalued.

Some investors still figure that when that yield is less than 3 percent you can either expect a significant increase in profits or a significant drop in stock prices.

Those who feel buybacks are a hidden dividend say not to worry. There may be some truth in that. But this is just the kind of talk you hear when stocks are at record levels - as they are now.