December is a big month for stock buybacks, and by month’s end, companies are expected to spend more money repurchasing shares this year than ever before. Not everyone is happy about it. Buybacks have been called everything from market manipulation and wage killers to a tax loophole and an executive compensation scheme. With US stocks widely expected to deliver lackluster gains in the years ahead, investors should call buybacks indispensable.
That’s because share repurchases have become a key component of total stock returns, although you might not know it based on recent buyback yields. Yes, companies in the S&P 500 Index spent $790 billion last year repurchasing shares, up from closer to $170 billion in 2000, based on the longest data compiled by Bloomberg. Goldman Sachs Group Inc. estimated in March that buybacks this year would be just short of $1 trillion and cross that milestone in 2025. But the S&P 500 is also more valuable than it was in 2000, and as a percentage of market value, buybacks are only modestly higher than they were at the time.
In fact, the S&P 500’s buyback yield peaked at 4.7% in 2007 and has trended lower ever since, landing at 2% last year. That doesn’t sound like much, particularly in a year when the index posted a total return of 26%, but a look at the longer record puts buybacks in a more enticing light.
Over the long run, stock returns come from mainly two sources: distribution of profits, traditionally in the form of dividends, and earnings growth. The S&P 500 and its predecessor index generated a total return of 9.3% a year since 1871. Of that, 4.6% came from dividends and 4.1% from earnings growth, while change in valuation contributed just 0.6%. (Changes in valuation grab a lot of attention and can have a big impact on total return in the short and medium term, but they’re mostly noise over the long term.)
Dividend yields have plunged in recent decades, averaging just 1.9% since 2000, but buybacks have picked up the slack. They added an average of 2.7% to dividends since 2000, boosting the average shareholder yield — that is, dividends and buybacks combined — to 4.6% over that time. So, while companies have changed the way they distribute profits to shareholders, the average shareholder yield remains roughly the same.
The pivot to buybacks from dividends is no coincidence. Regulators once frowned on buybacks, fearing that companies would use them to manipulate stock prices. That changed when the Securities and Exchange Commission gave its blessing to share repurchases in 1982. And a good thing, too, because buybacks make at least as much sense as dividends, and maybe more. They give companies the flexibility to distribute profits strategically, when they lack compelling investment opportunities, rather than on a preset schedule. And shareholders generally pay a lower tax rate on buybacks than on dividends.
Since 2000, buybacks have contributed more to shareholder yield than dividends in all but three years. Notable among them was 2009, a year in which companies missed an opportunity to buy back shares at bargain prices when stocks were beaten down by the financial crisis. In dollars and yields, buybacks that year were a fraction of their pre-crisis levels at the market peak in 2007, partly because the financial system was hobbled, and many companies were strapped for cash. Still, the experience of binging at the peak and having too little cash or courage to exploit the bust may explain why companies have been content to let buyback yields drift lower since the financial crisis amidst rising US stock valuations.
It’s easy to overlook those buyback yields when the S&P 500 rips higher, as it has in recent years. But they’re not so small in the context of realistic long-term stock returns, historical or expected. Consider that the S&P 500 has returned just 8% a year since 2000 through November. Or that many of the biggest money managers expect the market to deliver a more modest 3% to 6% a year over the next decade. Even if the market delivers its long-term annual return of closer to 9%, buyback yields would be a meaningful part of the payoff.
As for complaints about buybacks, they’re not terribly persuasive. A common one is that they divert money from investment that boosts companies’ value. But companies are not necessarily better off if they invest more, and they might be worse off. Shares of low-investment US companies, sorted on annual change in total assets and weighted by market value, have outpaced high-investment ones by 3 percentage points a year from 1963 through October, including dividends, according to numbers compiled by Tuck School of Business Professor Ken French. They also won 83% of the time over rolling 10-year periods. Those numbers suggest that profits are better off in the hands of shareholders than corporate executives.
Other knocks on buybacks are no more convincing. That includes their tax treatment, which is a matter for Congress, not companies and shareholders. The same goes for stubbornly low wages, a genuine problem mostly about how profits are shared between capital and labor and less about what capital does with its share. And while it’s true that buybacks boost earnings per share, a boon to corporate executives paid in stock, management’s job is to maximize the payoff to owners. If that’s best accomplished by handing profits to shareholders, as the data on investment implies, companies should do more of it.
But wherever you come out on those debates, take a moment to wish buybacks a happy December. Stock investing would be a lot less lucrative without them.
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