The Importance Of Dividends And Buybacks* Ratios For Gauging Equity Values

June 27, 2011

Why is analysis of dividend and buyback ratios rare in the industry?

If the dividend and buyback data is so important for monitoring the valuation levels of the market, one might ask why it is not a more common practice among index data providers. The fact is that data on index-level share buyback activity is currently not widely available (aside from the above insightful analysis provided by Standard & Poor's on the S&P 500 Index). To combat this dearth of data availability, WisdomTree began collecting data as of the trailing 12 months for the 2010 year-end on share buyback activity across its global index family, starting to help give context for how dividend and buyback ratios range in various parts of the world as well as in U.S. markets.

Aggregate US Share Buybacks Are Now Higher Than Aggregate US Dividends

To further explore the role of buybacks in the equity markets, we examined our in-house index series, and found that in the United States, share buybacks have surpassed dividends in terms of aggregate distributions to shareholders (see Figure 2). WisdomTree has two U.S. equity families. One family, the WisdomTree Earnings Indexes, is generally based on the profitable companies in the United States; the other, the WisdomTree Dividend Indexes, is generally based on the dividend payers in the United States.

Analysis of the buyback levels on these indexes reveal some key insights about what types of companies are issuing buybacks. This analysis is solely meant to be used as a commentary on how firms are distributing their cash to shareholders and the resulting implications for the overall valuation levels of WisdomTree's indexes and the markets covered by them.

  • Dividend Stream: The total aggregate dollar value of dividends paid for the WisdomTree Dividend Index as of Dec. 31, 2010 was $247 billion.
  • Buybacks: The total aggregate share buybacks over the prior 12 months for the WisdomTree Earnings Index as of Dec. 31, 2010 was $306 billion, about 24 percent higher than its trailing 12-month dividend stream.
  • The buybacks for the WisdomTree Dividend Index were $240 billion, about $66 billion below those of the WisdomTree Earnings Index. The higher level of buybacks for the Earnings Index is largely a result of technology companies preferring buybacks over dividends and the fact that technology stocks comprise the largest weight in the WisdomTree Earnings Index but are less represented in the WisdomTree Dividend Index. Technology sector companies comprised $80 billion of the $300 billion in buybacks from the Earnings Index total, or approximately 26 percent.

Because share buybacks function largely in the same theoretical way of returning firm cash to shareholders as paying dividends, an evaluation of the market's valuation ratios more appropriately includes analysis of the dividend yield and share buyback ratios. The buyback ratio for the index is calculated in a similar fashion as a dividend yield is calculated.6

Figure 2

Sources: WisdomTree, Bloomberg, S&P

The buyback ratio is a market valuation measure used to gauge what percentage of index market value is being reduced by share buyback activity of firms. The dividend and buyback ratio aggregates the dividends and buybacks together to represent a market valuation metric based on two common ways (dividends and buybacks) that firms distribute cash to shareholders.  


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