What will drive the return rate of U.S. stocks in the next decade? Trillion-dollar buybacks may become the main force

December is usually a big month for stock buybacks in the U.S., and this year, companies are expected to spend more on stock repurchases by the end of the month than ever before. Not everyone is pleased about this. Buybacks have been labeled everything from market manipulation and wage killers to tax loopholes and executive compensation schemes. However, with expectations that U.S. stock market gains will be lackluster in the coming years, investors should view buybacks as indispensable.

This is because stock buybacks have become a key component of total stock returns, even though recent buyback yields do not reflect this. According to compiled data, S&P 500 companies spent $790 billion on stock buybacks last year, up from $170 billion in 2000. Goldman Sachs estimated in March that buybacks this year would be slightly below $1 trillion and would cross that milestone by 2025. However, the S&P 500 is also more valuable than it was in 2000, and the proportion of buybacks to market capitalization is only slightly higher than it was then.

In fact, the buyback yield of the S&P 500 peaked at 4.7% in 2007 and has been on a downward trend since, falling to 2% last year. This doesn't sound high, especially in a year when the index's total return was 26%, but from a longer historical perspective, buybacks become more attractive.

Over the long term, stock returns primarily come from two sources: profit distribution (traditionally in the form of dividends) and earnings growth. Since 1871, the total annual return of the S&P 500 and its predecessor indices has been 9.3%. Of this, 4.6% comes from dividends, 4.1% from earnings growth, while changes in valuation contribute only 0.6%. (Valuation changes attract a lot of attention and can significantly impact total returns in the short to medium term, but in the long run, they are mostly just noise.)

In recent decades, dividend yields have declined significantly, averaging only 1.9% since 2000, but buybacks have compensated for this shortfall. Since 2000, companies have increased dividends by an average of 2.7%, raising the average shareholder yield (the sum of dividends and buybacks) to 4.6%. Therefore, although companies have changed the way they distribute profits to shareholders, the average yield for shareholders has remained roughly unchanged.

The shift from dividends to buybacks is not coincidental. Regulators were once opposed to buybacks, fearing that companies would use them to manipulate stock prices. This changed in 1982 when the U.S. Securities and Exchange Commission approved stock buybacks. This was a good thing, as buybacks are at least as meaningful as dividends, and possibly more so. When companies lack compelling investment opportunities, they can flexibly and strategically allocate profits rather than distributing them on a predetermined schedule. Moreover, the tax rate shareholders pay when buying back stock is often lower than that on dividends.

Since 2000, buybacks have contributed more to shareholder yields than dividends in all but three of those years. Notably, in 2009, when stocks were hit by the financial crisis, companies missed the opportunity to buy back shares at low prices In terms of dollars and yield, the repurchase scale that year was only a small fraction of the market peak before the 2007 crisis, partly due to the financial system being in distress and many companies facing cash shortages. Nevertheless, the lavish spending at the peak, with little cash or courage to leverage the experience of the bubble burst, may explain why companies have been content to let repurchase yields decline as U.S. stock market valuations have continued to rise since the financial crisis.

When the S&P 500 index soars, it is easy to overlook these repurchase yields, just as in recent years. However, from the perspective of long-term stock returns, whether historical or expected, repurchase yields are not as insignificant as imagined. Especially considering that from 2000 to November this year, the annual return of the S&P 500 index was only 8%. Alternatively, many of the largest fund managers expect the market to achieve moderate growth of 3% to 6% annually over the next decade. Even if the market achieves a long-term annual return close to 9%, repurchase yields will be an important component of that return.

As for complaints about repurchases, they are not very convincing. A common phenomenon is that repurchases divert funds away from investments that enhance company value. But if companies invest more, the situation may not necessarily improve; it could even worsen. According to data compiled by Ken French, a professor at the Tuck School of Business, from 1963 to October, U.S. companies with low investment (ranked by annual change in total assets and weighted by market capitalization) outperformed high-investment companies by 3 percentage points annually. Over a rolling 10-year period, low-investment U.S. companies performed better 83% of the time. These figures suggest that having profits more in the hands of shareholders is better than having them in the hands of company executives.

Other criticisms of repurchases are also no longer convincing. This includes tax treatment, which is something Congress needs to address, rather than companies and shareholders. Stubbornly low wages are also a real issue, primarily concerning how profits are distributed between capital and labor, rather than how capital manages its distribution. While repurchases can indeed boost earnings per share, which is a boon for company executives compensated with stock, management's job is to maximize shareholder returns. If, as investment data suggests, returning profits to shareholders is the best way to achieve this goal, then companies should do more