The Supply of Stock Returns: Adding Back Buybacks

TLDR: In this article, the authors provide theoretical and empirical evidence for a total payout (dividends plus buybacks) model of stock returns, and show that long-run stock returns between 1871 and 2014 can almost entirely be attributed to the supply of total payouts.

Abstract: The shift in corporate payout policy from dividends to buybacks creates the need for a new supply model of stock returns. Our study provides theoretical and empirical evidence for a total payout (dividends plus buybacks) model of stock returns. First, we show that long-run stock returns between 1871 and 2014 can almost entirely be attributed to the supply of total payouts. Second, we provide evidence that total payouts per-share (adjusted for the share decrease from buybacks) grow in line with economic productivity, and that aggregate total payouts grow in line with GDP. Third, we demonstrate that the dividend discount model (DDM), based on current yields and historical growth rates, significantly underestimates forward-looking equity return compared to a total payout model that includes both dividends and buybacks. Fourth, we show that the cyclically-adjusted total yield (CATY) is at least as good of a predictor of changes in expected returns as the cyclically-adjusted price-to-earnings ratio (CAPE).