December is usually a big month for buybacks in the USA stock market, and this year it is expected that companies will buy back more stocks by the end of the month than ever before. Not everyone will be pleased about this. Buybacks are referred to everything from market manipulation and wage killers to tax loopholes and executive compensation plans. However, because it is generally expected that the growth of USA stocks will be meager in the coming years, investors should consider buybacks as essential.

This is because share buybacks have become a key component of total stock returns, even though the reasons for this are not evident from recent buyback yields. According to compiled data, S&P 500 Index constituents spent USD 790 billion on stock buybacks last year, up from USD 170 billion in 2000. Goldman Sachs estimated in March that this year's buybacks would be slightly less than USD 1 trillion and would cross this milestone by 2025. However, the S&P 500 Index is also more valuable than it was in 2000, and buybacks account for only slightly more of the Market Cap than at that time.

In fact, the buyback yield of the S&P 500 Index peaked at 4.7% in 2007 and has been declining since, dropping to 2% last year. This may not seem high, especially in a year when the total ROI for the index was 26%, but looking at a longer historical record, buybacks become more attractive.

In the long run, stock returns mainly come from two aspects: profit distribution (traditionally in the form of dividends) and earnings growth. Since 1871, the total ROI for the S&P 500 Index and its predecessor indices has averaged 9.3% per year. Of this, 4.6% comes from dividends, 4.1% from earnings growth, while changes in valuation only contributed 0.6%. (Changes in valuation attract a lot of attention and can have a significant impact on total returns in the medium short term, but in the long run, they are mostly just noise.)

In recent decades, dividend yields have significantly declined, averaging only 1.9% since 2000, but buybacks have compensated for this shortfall. Since 2000, companies have increased dividends by an average of 2.7%, during which time the average shareholder yield (sum of dividends and buybacks) has risen to 4.6%. Therefore, even though companies have changed the way profits are distributed to shareholders, the average yield for shareholders has largely remained the same.

The shift from dividends to buybacks is not coincidental. Regulators once disapproved of buybacks, fearing companies would use them to manipulate stock prices. This changed in 1982 when the SEC approved stock buybacks. This was a good thing because buybacks are at least as meaningful as dividends, and possibly more so. When companies lack compelling investment opportunities, they can flexibly allocate profits strategically rather than distributing them on a set timetable. Moreover, the tax rates paid by shareholders when stocks are bought back are usually lower than those on dividends.

Since 2000, buybacks have contributed more to shareholder yields than dividends all but three of those years. Notably, in 2009, when stocks were hit by the financial crisis, companies missed the opportunity to buy back stock at a low stock price. In terms of dollars and yield, that year's buyback scale was only a small part of the pre-crisis market peak in 2007, partly because the financial system was in distress, and many companies faced cash shortages. Nevertheless, the lavish spending during peaks, coupled with a lack of cash or courage to leverage experiences from the burst of the bubble, may explain why since the financial crisis, companies have been content to let buyback yields decline as USA stock valuations continue to rise.

When the S&P 500 Index soars, it's easy for people to overlook these Share Buyback returns, just as in recent years. However, from the perspective of long-term Stocks ROI, whether historical or expected, the Share Buyback returns are not as insignificant as imagined. Especially considering that from 2000 to November this year, the annual return rate of the S&P 500 Index has only been 8%. Alternatively, many of the largest Funds managers expect moderate growth of 3% to 6% annually in the market over the next decade. Even if the market achieves close to a 9% long-term annual return rate, the Share Buyback returns will be an important component of the returns.

As for complaints about Share Buybacks, they are not very convincing. A common phenomenon is that Share Buybacks divert funds from investments that enhance company value. But if a company invests more, the situation may not necessarily improve; it could actually get worse. According to data compiled by Professor Ken French from Tuck School of Business, including dividends, from 1963 to October, the stock prices of low-investment American companies (ranked by annual changes in total assets and weighted by Market Cap) outperformed high-investment companies by 3 percentage points every year. Over a rolling 10-year period, low-investment American companies performed better 83% of the time. These figures suggest that having more profits in the hands of Shareholders is better than in the hands of Company Executives.

Other critiques of Share Buybacks are no longer convincing. This includes tax treatment, which is something Congress needs to address, rather than companies and Shareholders. Stubbornly low wages are also a genuine issue, primarily concerning how profits are distributed between capital and labor, rather than how capital manages its distribution. While Share Buybacks can indeed enhance EPS, which is a boon for Company Executives whose compensation is in Stocks, management's job is to maximize Shareholders' returns. If handing profits to Shareholders is the best way to achieve this goal, as investment data suggests, then companies should do more.

Editor/lambor