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

June 27, 2011

There are a number of takeaways from our analysis of dividend and buyback ratios on WisdomTree indexes and how they fit into the above formula for the markets.

The total return decomposition serves as a reminder about how one must constantly evaluate the trade-off between starting dividend yield and future growth rates of dividends when arriving at return expectations for a given market. Indexes that start out with higher dividend yields must rely less on an uncertain future growth of dividends.

When we look at what the dividend and buyback ratios foretell for the overall market valuation ratios, we see a fairly attractive picture. John Hussman was bearish quoting the S&P 500 with a dividend yield close to 2 percent. But this commentary points out that one must include analysis of share buybacks. When one adds that into the S&P 500 dividends, the combined dividend and buyback ratio is closer to 4.5 percent.

When we see the dividend and buyback ratio of the WisdomTree Dividend Index above 5 percent—and one adds on top of that any normal expectation for future dividend growth—we see a broad U.S. equity market that looks very reasonably priced. Moreover, WisdomTree's regional equity income indexes had combined dividend and buyback ratios of 5.5 percent to 5.9 percent, which represent to us even more attractive valuations for those indexes, especially when compared to the most common alternative asset class of choice: U.S. bonds.

Disclosures

You cannot invest directly in an index. Index performance does not represent actual fund or portfolio performance. A fund or portfolio may differ significantly from the securities included in the index. Index performance assumes reinvestment of dividends, but does not reflect any management fees, transaction costs or other expenses that would be incurred by a portfolio or fund, or brokerage commissions on transactions in fund shares. Such fees, expenses and commissions could reduce returns.

Endnotes

* Share buybacks are defined as a company using cash to repurchase shares from investors, thus reducing the company's shares outstanding.

2. The dividend yield of the S&P 500 is defined as index dividends per share divided by index price.

3. Hussman, John, "No Margin of Safety, No Room for Error," Oct. 11, 2010, http://www.hussmanfunds.com/wmc/wmc101011.htm

4. Source: Robert Shiller, http://www.econ.yale.edu/~shiller/

5. Share buybacks support higher prices because they reduce the shares outstanding for a company, and assuming the same total dividends or earnings, increase the per-share dividends or earnings of a firm. Assuming no change in the valuation ratios, the growth in per-share earnings or dividends should lead to a higher stock price.

6. The calculation aggregates buybacks per share times index shares divided by the index market value (price per share times index shares).

Additional index information is available at www.wisdomtree.com

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