Buttonwood: Bumper buy-backs
A new paper argue that to forecast share returns, buy-backs as well as dividends must be counted.
What is the point of buying shares?
Ultimately investors must hope that the cash they receive from the company will offer an attractive long-term return.
Over the long run, reinvested dividends rather than capital gains have comprised the vast bulk of returns.
But since the 1980s American firms have increasingly used share buy-backs, which have tax advantages for some investors.
Buy-backs have been higher than dividend payments in eight of the past ten years.
In a buy-back, investors receive cash for a proportion of their holdings.
A new paper in the Financial Analysts Journal argues that adding this to dividend receipts to calculate a total payout yield gives a better estimate of future returns than the dividend yield alone.
It also reveals a much better match between stockmarket performance and overall economic growth.
Using data going back to 1871, the authors find that the average dividend yield has been 4.5% and the total payout yield 4.89%.
Since 1970 the dividend yield has dropped to 3.03%, but the total payout yield has averaged 4.26%.
Looked at on that basis, the overall income return from shares has been not that far below historical levels.
The return from shares can be broken down into three components: the initial income yield; growth in the income stream; and any change in valuation.
(If shares become more expensive, the yield will fall.
Say the dividend is $6 and the share price is $100, the initial yield will be 6%.
If the shares rise to $120, the yield will fall to 5% but the investors will have made a capital gain.)
Over the long run, changes in valuation levels do not make much difference to the return.
What has driven stockmarket returns in recent decades is that total payouts have grown faster than before.
The growth rate since 1871 has been 2.05%; since 1970, it has been 3.44%.
That is probably because of strong corporate profits, which recently hit a post-1945 high as a proportion of America's GDP.