Buybacks have outperformed the market for most of the last twenty years, but total shareholder return has been even more important, according to research from the Goldman Sachs Portfolio Strategy team. They found that the S&P 500 (INDEXSP:.INX) has doubled buybacks over the last decade and that companies involved in large buybacks beat the market by an average of 5.3 percent per year for the last two decades, and that choosing stocks based on tot cash returns (buybacks plus dividend yields) averaged 6.2 outperformance per year.

Shareholder yield beat the market

“Those with the largest buyback programs have led the S&P 500 (INDEXSP:.INX) by 970 bp in 2013, while those with the highest total shareholder yields have beaten the market by 1040 bp YTD each on a sector-neutral and equal-weight basis,” the report says. “Those returns continue a trend over the past 20 years that makes a compelling investment case with a few notable caveats.”

The case for investing in companies with large buybacks is simple enough that it has already inspired a few indices, including the S&P Buyback Index and two new vehicles that Goldman Sachs Group Inc (NYSE:GS) is showcasing with this research, the Buyback basket and the Total Cash Return to Shareholder basket. Both vehicles back test well, which wouldn’t surprise anyone already familiar with this investment idea, as the size of a company’s buybacks correspond to performance pretty well.

stock performance by buybacks size

buyback outperforms market

Buyback difference between sectors

Looking solely at buybacks ignores some real differences between sectors. As one example, the IT sector participated in buybacks to a much lesser extent than other sectors during the tech bubble, so when it collapsed, buyback performance was artificially boosted simply because it excluded a failing part of the economy. The bubble didn’t pop because firms weren’t involved in buybacks, it was because they weren’t earning any money.

This effect is also diminished when you only look at the last ten years, and that might be due to bad data. “SEC disclosure rule changes in 2004 improved the quality of buyback data, and many in the academic literature disregard data prior to 2004 as unreliable,” the report says. This doesn’t eliminate the effect by any means, but it does mitigate it. Ironically, it’s actually promising that the diminishing effect can be blamed on poor data, because otherwise there could be an underlying cause that could make buybacks a bad strategy in the future.

But when these two effects are taken into account, the equal weighted returns still outperform by 135 basis points annually when you choose stocks with the highest buybacks.