December Deluge: U.S. Companies Gear Up for Record-Breaking Buybacks Amid Criticism and Opportunity

In December, U.S. equities traditionally experience a surge in stock buybacks, and this year, companies are expected to allocate more funds towards buybacks than ever before. Despite some critics labeling buybacks as market manipulation and a tax loophole, they are seen as essential amid expectations of modest equity gains in the coming years.

Stock buybacks have become a significant contributor to total shareholder returns, accounting for a substantial portion despite not showing directly in buyback yields. For instance, S&P 500 firms spent $790 billion on buybacks last year. Projections from earlier this year suggested buybacks nearing $1 trillion and possibly surpassing that by 2025. The market value of the S&P 500 has increased significantly since 2000, and though buybacks as a percentage of market cap are not drastically higher, their role remains pivotal.

The buyback yield for the S&P 500 peaked at 4.7% in 2007 but dropped to 2% last year. While this may appear low in a year with a 26% total return, it holds long-term appeal. Since 1871, S&P 500 and its predecessors have delivered an average annual total return of 9.3%, majorly driven by dividends and earnings growth, with dividends contributing about 4.6%. However, since 2000, dividends have averaged just 1.9%, with buybacks compensating for the gap. This shift has maintained shareholder returns, as dividends and buybacks together have generated an average yield of 4.6% for shareholders.

The transition from dividends to buybacks is not coincidental. Once discouraged due to fears of price manipulation, the approval of buybacks by the SEC in 1982 allowed companies flexibility in allocating profits strategically. This flexibility becomes crucial in the absence of lucrative investment opportunities, allowing companies to optimize shareholder returns, often with favorable taxation compared to dividends.

Aside from a few exceptions, buybacks have consistently contributed more to shareholder yield than dividends since 2000. A notable miss was in 2009 during the financial crisis when companies, facing liquidity issues, reduced buybacks significantly. However, since then, a cautious approach amid rising valuations has led to lower buyback yields. Even with the S&P 500’s moderate 8% annual return since 2000, buybacks play a critical role, underscoring their importance even as future growth is projected to be modest.

While skeptics argue that buybacks divert funds from potentially valuable investments, data suggests otherwise. Historical analysis shows that low-investment firms have consistently outperformed high-investment counterparts. Therefore, distributing profits to shareholders might be more advantageous than retaining them within companies. Moreover, concerns about buybacks related to taxation and executive compensation should be addressed separately as they are not inherently problematic. Ultimately, if returning profits to shareholders maximizes returns, increased buyback activity can be justified.