The return of capital by companies to shareholders is a key contributor to long-term returns. A forthcoming study by Morningstar’s Philip Straehl and Yale’s Roger Ibbotson attributes more than two-thirds of the real (inflation-adjusted) return in stock prices for the period of 1871 through 2014 to total yield.

Return of capital includes both dividends and stock repurchases. Dividends, the distribution of cash to shareholders, have a longer history of driving historical stock returns. The increased prominence of buybacks—the repurchase of shares by companies—is attributed to a rule adopted by the Securities and Exchange Commission in 1982. Straehl and Ibbotson found a gradual substitution of buybacks for dividends starting in the early 1980s. They say this shift has resulted in buybacks surpassing dividend payments in eight out of the last 10 calendar years.

Buybacks are not without controversy. Unlike dividends, there is rarely a penalty for a company not repurchasing all of the shares authorized by a buyback program. (CEOs, however, might face the ire of activist investors.) Stock buybacks also can inflate earnings per share growth by simply reducing the number of shares outstanding. Since buybacks increase the proportionate ownership of a company each share represents, earnings per share can increase even when net income is flat or declines slightly when a company reduces the number of shares outstanding.

Dividends have no impact on earnings, with the exception of distributing cash that could hypothetically be used for growth purposes (in which case, future earnings would be affected). A reduction or suspension of a dividend is a negative event leading to the share price being penalized. Such events are often viewed as evidence of poor business conditions and/or weak underlying fundamentals.

According to economic theory, an investor should be indifferent to dividends or buybacks. Dividends return cash to shareholders. Buybacks increase ownership, giving shareholders a bigger claim to future earnings and larger dividend payments—assuming dividend payout ratios are unchanged and net income is essentially stable. Shareholder yield plays into this concept. Shareholder yield is the sum of the dividend yield (dividends divided by share price) and the buyback yield (the percentage change in the number of shares outstanding). Companies with positive levels of shareholder yield outperform companies with negative levels of shareholder yield. Straehl and Ibbotson used a similar concept to shareholder yield to explain the key drivers of stock returns. Setting aside the mathematical formulas, they show how stock returns have been driven by the total (shareholder) yield, growth in total payout (cash returned to shareholders via dividends and buybacks), the change in share price to total payout and inflation plus a small measure to account for the interaction between these factors.

In the real world, investors consider factors such as the role dividends play in forcing executives to not take excessive risks (because of the penalties associated with cutting or suspending the dividend), the stream of cash from dividends, the noncommittal aspects of buybacks, the positive return attributes of rising dividends, and the ability to delay realizing taxes by opting for non-dividend-paying stocks over dividend-paying stocks. (The tax rates for qualified dividends and long-term capital gains are the same; only the timing of when a taxable event is realized differs.) As such, there are legitimate reasons for favoring dividends or buybacks.

Regardless of personal preference, the bigger message is that the return of capital to shareholders is a positive trait to seek in a stock.

• “What Works”: Key New Findings on Stock Selection – Jim O’Shaughnessy discussed how he uses shareholder yield as part of a composite valuation measure.
  
• Stock Buybacks: Misunderstood, Misanalysed and Misdiagnosed – Aswath Damodaran explained how buybacks can be a positive or a negative event for shareholders.
  

• Piotroski Price-to-Book Screen – AAII President John Bajkowski shows how the F-Score, which analyzes a company’s underlying financial strength, can be used for stocks with high and low valuations in the new June AAII Journal.
  
• The Dual Personalities of Investors – Turbulent markets often cause investors’ personalities to move into a “dark zone.”
  

Two stocks were sold from the Model Shadow Stock Portfolio and one stock was added. An alert detailing the transactions was issued yesterday after the close of trading. Members can receive the alerts by signing up for the Model Portfolio Update email.

AAII President John Bajkowski will give our Rochester, NY, chapter suggestions on how to find a winning stock on Wednesday.

Just two members of the S&P 500 are scheduled to report earnings: Brown-Forman Corporation (BF.B) on Wednesday and J.M. Smucker Co. (SJM) on Thursday.

The week’s first economic reports will be revised first-quarter productivity, April factory orders and the May ISM non-manufacturing index, all of which will be released on Monday. Tuesday will feature the Labor Department’s April job openings and labor turnover survey (JOLTS).

Optimism among individual investors about the short-term direction of the stock market is at an unusually low level for the second time in three weeks. At the same time, the latest AAII Sentiment Survey shows neutral sentiment being back above 40%. Pessimism is also higher this week.

Bullish sentiment, expectations that stock prices will rise over the next six months, pulled back by 5.9 percentage points to 26.9%. The drop keeps optimism below its historical average of 38.5% for the 19th time out of the last 20 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 4.4 percentage points to 41.5%. The rise keeps neutral sentiment above its historical average of 31% for the fifth consecutive week and the 10th time in 11 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 1.5 percentage points to 31.5%. The historical average is 30.5%.

Optimism is at an unusually low level, as noted above, and neutral sentiment is at an unusually high level for the second time in three weeks. Unusually low bullish sentiment readings have historically been followed by above-average returns for the S&P 500 index over the following the six- and 12-month periods, though there is no guarantee that this trend will recur in the future.

This week’s special question asked AAII members what factors are most influencing their six-month outlook for stocks. Slightly more than half of all respondents (51%) said politics. The overwhelming majority of these respondents specifically referenced President Donald Trump. About 13% of all respondents said earnings were influencing their outlook, while an equal percentage said interest rates and monetary policy. Slightly more than 12% referenced the economy. Approximately 8% referenced geopolitics. Some respondents listed more than one factor.

Here is a sampling of the responses:

• "The Trump political situation.”
• "Lack of progress in repealing the Affordable Care Act and reforming the tax code.”
• "Rising interest rates and the lack of other investment options.”
• "The stock market at present is way overvalued.”
• "The positive earnings season just completed.”

Bullish: 26.9%, down 5.9 points
Neutral: 41.5%, up 4.4 points
Bearish: 31.5%, up 1.5 points


Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%

Individual investors’ fixed-income allocations fell to a two-year low last month, according to the May AAII Asset Allocation Survey. Both equity and cash allocations rose.

Stock and stock fund allocations rebounded by 2.1 percentage points to 67.4%. The rise puts equity allocations at their second-highest level of the year. May was the 50th consecutive month that equity allocations were above their historical average of 60.5%.

Bond and bond fund allocations fell 2.5 percentage points to 15.5%. Fixed-income allocations were last at this level during the three-month span of May through July 2015. The historical average is 16.0%.

Cash allocations increased by a modest 0.4 percentage points to 17.2%. May was the 66th consecutive month that cash allocations were below their historical average of 23.5%.

Yields on the benchmark 10-year Treasury note generally declined last month, while the S&P 500 index and the NASDAQ set new highs. Expectations for a short-term increase in stock prices remained below average throughout the month, according to our weekly Sentiment Survey. At the same time, low yields and the potential for the Federal Reserve to raise interest rates further continue to reduce the appeal of bonds in the eyes of many individual investors.

Last month’s special question asked AAII members if they are overweighting or underweighting stocks. Nearly 43% of respondents said they overweighting stocks. Many of these respondents cited the long-term performance of stocks, while others said they are seeking dividends or don’t view bonds as being attractive right now. Slightly more than 23% of respondents said they are underweight stocks. Valuations were the primary reason. Another 23% of respondents said they either have an appropriate allocation or are equal weight.

Here is a sampling of the responses:

• “Overweighting stocks; bonds return nothing and will go down with rising interest rates.”
• “Equal weighting. I’m finding fewer values as the market continues to appreciate.”
• “Overweight due to dividend yield and a long-term view that the market will continue go up.”
• “Underweighting due to valuations.”
• “Neither. I’m conforming to my long-term portfolio allocation strategy.”

• Stocks and stock funds: 67.4%, up 2.1 percentage points
• Bonds and bond funds: 15.5%, down 2.5 percentage points
• Cash: 17.2%, up 0.4 percentage points

• Stocks: 34.7%, up 0.4 percentage points
• Stock Funds: 32.7%, up 1.7 percentage points
• Bonds: 4.1%, down 1.6 percentage points
• Bond Funds: 11.4%, down 1.0 percentage points

Take the Asset Allocation Survey.

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