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

June 27, 2011

Key data highlights as of Dec. 31, 2010:

  • The buyback ratio of the WisdomTree Earnings Index at 2.47 percent is about 30 percent greater than its dividend yield of 1.9 percent, and when dividends and buybacks are added together, the combined dividend and buyback ratio is 4.4 percent.
  • By contrast, the dividend yield of the WisdomTree Dividend Index at 3.2 percent is more than 50 percent greater than its buyback ratio of 2.1 percent. When dividends and buybacks are added together, the combined dividend and buyback ratio is 5.3 percent.
  • By these measures, the combined dividend and buyback ratio of the WisdomTree Dividend Index, at above 5 percent, implies that valuation levels for WisdomTree's indexes are reasonably similar to the historical norms of the S&P 500 Index when buybacks were much less common practice.
  • Small-caps had lower buyback ratios than large-caps. Both within the dividend-weighted and earnings-weighted index families, small-caps had approximately 1 percentage point of lower buyback ratios compared with the large-caps.

In addition to the data focused on the United States, we also examined dividend and buyback ratios across global indexes (see Figure 3). Some takeaways from global analysis (all data below as of the trailing 12-month period as of Dec. 31, 2010):

  • United States-based firms engaged in significantly more share buyback activity than foreign firms. The total global aggregate buybacks of the WisdomTree Global Dividend Index were $282 billion, of which the U.S. firms represented 85 percent of all global share buybacks.
  • The WisdomTree Global Dividend Index had a buyback ratio of just 0.70 percent compared with 2 percent for the U.S. WisdomTree Dividend Index and 2.5 percent for the U.S. WisdomTree Earnings Index.
  • The emerging markets engaged in more share buybacks than foreign developed markets and display higher buyback ratios than foreign developed markets. The aggregate share buybacks of the WisdomTree Emerging Markets Dividend Index was $26 billion, compared with just $14 billion from the WisdomTree DEFA Index, which is a dividend-weighted index of the developed world dividend payers.
  • The combined dividend and buyback ratios across WisdomTree's four regional equity income indexes are remarkably similar, all within a range of 5.6 to 5.9 percent. The U.S. Equity Income Index had the lowest dividend yield of the group at 4.35 percent, but its buyback ratio was the highest at 1.41 percent, giving it a combined dividend and buyback ratio in the middle of the range of the various regions.
  • Within the small-cap segment of the market, the U.S.-based dividend index had the highest combined dividend and buyback ratio, at 5.2 percent. The second-highest dividend and buyback ratio was for the Emerging Markets SmallCap Dividend Index, which was higher than those of the Developed International and Europe SmallCap Dividend Indexes.

Conclusion

At the beginning of this research piece, we cited a formula often used in setting return expectations for the equity markets that decompose the total return into three components:

  1. The starting dividend yield, plus …
  2. The growth rate of dividends, plus …
  3. A factor representing the change in valuation ratio (or the change in the dividend yield from the beginning to the end of the period)

Figure 3
Sources: WisdomTree, S&P, Bloomberg

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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