The Market Yields What???

August 24, 2006

Add in stock buybacks with dividends and the S&P 500 yields a fat 5.34 percent.

Dividend investors like to point to the S&P 500's miserly 1.8 percent yield and laugh. Sure, the index's dividend payout is up from its 1999 lows, when "dividend" was a bad word on Wall Street and the index paid a puny 1.1 percent.  But 1.8 percent ain't going to pay for mother's retirement.

The low yield on cap-weighted indexes is part of the reason why investors have so eagerly embraced the wave of dividend-focused funds that have hit the market since 2003. These dividends funds seem to launch every week - Vanguard just filed for the right to launch its fourth dividend fund today - and, amazingly, they all seem to succeed. The flagship fund in this segment is the iShares Dow Jones Select Dividend Fund (NYSE: DVY), which has attracted a stunning $6.5 billion in assets since hitting the market in 2003. But funds from PowerShares, Vanguard and others have done well, too.

New research from Standard and Poor's, however, paints a different and more flattering picture of the S&P 500's yield. According to S&P, if you add in stock buybacks to dividends, the S&P 500's yield jumps to 5.34 percent. 5.34 percent!  That's enough to make the dividend-friendly markets in Canada and Australia blush.

S&P says that companies in its 500 index have spent a stunning $116 billion on stock buybacks in the second quarter, up 43 percent from 2005 levels and a stunning 175 percent from 2004. If you're doing the math, that's about $2 billion a day.

In some ways, buybacks are similar to dividends: They are a way of returning money to shareholders. In theory, the fewer shares available on the market, the greater the value of each share. The relationship is not perfect, however, because companies are able to re-issue shares at a later date.  But there is a relationship between buybacks and stock values. (In fact, Claymore Advisors plans to launch an ETF tracking an index of companies that are buying back stock.)

"The record $116 billion in buybacks is the result of over 40% of the S&P 500 companies reducing their share count during the second quarter," says Howard Silverblatt, Senior Index Analyst at Standard & Poor's.  "The unprecedented expenditure on buybacks and the resulting share count reduction is having a material affect on both earnings-per-share and cash flow. Left unabated, this will eventually impact the supply of open market shares, and therefore the share price itself."

With bank accounts paying just over 4 percent, and bonds yielding not much more than that, the 5.34 percent buyback/dividend yield doesn't look half bad.

The enormous buybacks also show something that's been obvious to index watchers for some time: Despite relatively flat returns in the market, corporate America is swimming in cash right now, and they don't know what to do with it. According to S&P, companies spent as much money on stock buybacks over the past twelve months as they have on capital equipment expenditures.

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