Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
Nicolas Perrault
Posts: 209
Joined: Thu Sep 27, 2018 12:33 pm
Location: Oxford, UK

Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by Nicolas Perrault » Thu May 28, 2020 8:50 pm

To simplify, suppose all TSM companies have 3% earnings. Suppose half the companies are “growth” companies yielding 0% in dividends (none of their earnings), and half are “value” companies yielding 3% dividends (all of their earnings). So the growth companies are reinvesting into themselves to, well, grow. And the value companies are giving investors everything they earn in dividends. This simplified “TSM” fund yields therefore 1.5%, the average of the yields of the growth and value companies.

Now if as an investor I take that 1.5% dividend and reinvest it into this TSM index, I am using half of this amount to buy value companies and half to buy growth companies. So I am in fact using the earnings of the value companies to invest 50% in growth companies, and the earnings of the growth companies to invest 100% in growth companies. In effect, 75% of the earnings of this index are reinvested into growth companies, and 25% in value companies. How is this fair, for lack of a better word, to value companies?

I’ve wondered about this for some time. Are there any implications to this for an investor? Or is it unimportant?

Can reinvesting TSM dividends artificially inflate the importance of growth companies in one’s portfolio? That’s hard to imagine in a 100% TSM portfolio, what am I missing?

User avatar
arcticpineapplecorp.
Posts: 5286
Joined: Tue Mar 06, 2012 9:22 pm

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by arcticpineapplecorp. » Thu May 28, 2020 8:58 pm

when you get a dividend the price of the fund drops accordingly. if you reinvest you end up the same place you started before the dividend was paid montetarily, but have slightly more shares.

if the market portfolio is weighted according to market cap, then reinvesting dividends back in clearly has to reinvest them back in at market cap too, regardless of whether the dividends are coming from value or growth companies as you imply.

You end with market cap, same as you started before the dividend was paid, no?
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

magicrat
Posts: 1006
Joined: Sat Nov 29, 2014 7:04 pm

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by magicrat » Thu May 28, 2020 9:05 pm

Would you prefer to reinvest back into those dividend paying companies that have told you they have no use for cash?

User avatar
Topic Author
Nicolas Perrault
Posts: 209
Joined: Thu Sep 27, 2018 12:33 pm
Location: Oxford, UK

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by Nicolas Perrault » Thu May 28, 2020 9:10 pm

arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.

User avatar
grabiner
Advisory Board
Posts: 27165
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by grabiner » Thu May 28, 2020 9:49 pm

When a corporation pays a dividend (or buys back stock), its assets decline. The net effect is that stocks which pay lower dividends will become a larger part of the stock market.

However, this does not create an inherent bias towards growth stocks, because stocks move between growth and value as the market changes. If you hold a 50/50 split of a growth index and a value index, and rebalance to that allocation, you will have the same portfolio as a blend index. (In contrast, if you start with a 50/50 split, and reinvest dividends 50/50 without rebalancing, you will have more in the growth index if growth and value have equal returns.)
Wiki David Grabiner

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Thu May 28, 2020 9:54 pm

Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm
arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.

willinghamt19
Posts: 13
Joined: Fri Oct 18, 2019 2:16 pm

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by willinghamt19 » Thu May 28, 2020 9:55 pm

You’re right in a sense, but the price of the “value” companies is already inflated by the present value of their expected and then announced dividend. So when you reinvest dividends, you get the value companies still at the “appropriate” price.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Thu May 28, 2020 10:05 pm

grabiner wrote:
Thu May 28, 2020 9:49 pm
When a corporation pays a dividend (or buys back stock), its assets decline. The net effect is that stocks which pay lower dividends will become a larger part of the stock market.

However, this does not create an inherent bias towards growth stocks, because stocks move between growth and value as the market changes. If you hold a 50/50 split of a growth index and a value index, and rebalance to that allocation, you will have the same portfolio as a blend index. (In contrast, if you start with a 50/50 split, and reinvest dividends 50/50 without rebalancing, you will have more in the growth index if growth and value have equal returns.)
I don't believe this answer really addresses the question.

Look, I understand if growth stocks do well, you will still have a similar value growth split. Growth stocks simply get pushed into the value side. The opposite is also true if value stocks outperform.

Look at it though if we were talking about two companies. One pays dividends, the other doesn't.


1) Before dividend payment:
|—————Company A $100—————|—————Company B $100—————|
|—————Company A 50% —————|—————Company B 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Company A $97 ———|———Company B $100———|—Cash $3 —|
|———Company A 48.5%———|———Company B 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Company A $98.48 ————|—————Company B $101.52—————|
|—————Company A 49.24%—————|—————Company B 50.76%—————|

Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|
Last edited by typical.investor on Thu May 28, 2020 10:21 pm, edited 1 time in total.

User avatar
JoMoney
Posts: 9338
Joined: Tue Jul 23, 2013 5:31 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by JoMoney » Thu May 28, 2020 10:10 pm

Does selling off shares of TSM "artificially" deflate one's position in growth stocks?
I would say no. You continue to hold the portfolio by its float-adjusted market cap weight.

It seems to me, reinvesting dividend in the same security could create more "artificial inflation" as the dividend wouldn't be reinvested at float-adjusted market weights and increase demand for that specific security, which could then be susceptible to people front-running the expected increased demand when the dividend was paid. When a company does a share buy back, they don't announce exactly when it's going to be done because they don't want to be front-run, but a dividend has to be announced, and a large group of shareholders that would be purchasing more shares for their own portfolio at that known time would have the same effect.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Thu May 28, 2020 11:07 pm

JoMoney wrote:
Thu May 28, 2020 10:10 pm
Does selling off shares of TSM "artificially" deflate one's position in growth stocks?
I would say no. You continue to hold the portfolio by its float-adjusted market cap weight.
Yes or no to your question to selling doesn't matter. It's irrelevant to the question of whether dividend reinvestment in TSM affects P/E.

What we are talking about is earnings. If earnings from non-dividend paying stocks are retained, but earnings from dividend payers are used to buy both non-dividend paying stocks and dividend payers -- that will affect P/E ratios.

I don't see or expect a mechanism by which selling TSM affects the P/E of one stock relative to another. That, however, doesn't mean that dividend reinvestment won't.
JoMoney wrote:
Thu May 28, 2020 10:10 pm
It seems to me, reinvesting dividend in the same security could create more "artificial inflation" as the dividend wouldn't be reinvested at float-adjusted market weights and increase demand for that specific security, which could then be susceptible to people front-running the expected increased demand when the dividend was paid. When a company does a share buy back, they don't announce exactly when it's going to be done because they don't want to be front-run, but a dividend has to be announced, and a large group of shareholders that would be purchasing more shares for their own portfolio at that known time would have the same effect.
I don't see how dividend front running could be very effective. Just because a dividend is paid by a stock, it doesn't mean reinvestment will immediately occur. Mutual funds and ETFs hold the dividend in cash until their scheduled distribution.

Why could a hedge fund do? Purchase a stock after it issues a dividend and look at when all the mutual funds and ETFs holding that stock will reinvest their dividends, and then sell the stock after all those mutual funds and ETFs have reinvested? Wow, even for a single stock, it seems like dividend reinvestment would occur at different times due to different mutual fund and ETF distribution schedules.

Also, as shown previously, you wouldn't be able to count on a dividend payers stocks being reinvested in that stock. It might actually be going into a non-dividend payer who is retaining its earnings.

It seems like you would get weird exposure to the market and I wouldn't expect it to be widely used. Someone please cite something if you can find a study of "dividend front running".

In any case, whatever effect that "dividend frontrunning" might have, I wouldn't expect it to negate the P/E changes induced when TSM funds reinvest the dividends from dividend paying stocks into stocks that retain their earnings.

marcopolo
Posts: 3068
Joined: Sat Dec 03, 2016 10:22 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by marcopolo » Thu May 28, 2020 11:30 pm

typical.investor wrote:
Thu May 28, 2020 9:54 pm
Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm
arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Once in a while you get shown the light, in the strangest of places if you look at it right.

User avatar
JoMoney
Posts: 9338
Joined: Tue Jul 23, 2013 5:31 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by JoMoney » Thu May 28, 2020 11:38 pm

typical.investor wrote:
Thu May 28, 2020 11:07 pm
... Mutual funds and ETFs hold the dividend in cash until their scheduled distribution...
That's not universally the case. Some do, some don't. In the case of index funds, the only one I'm aware of that doesn't reinvest dividends until their distribution is the SPY ETF.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Thu May 28, 2020 11:38 pm

marcopolo wrote:
Thu May 28, 2020 11:30 pm
typical.investor wrote:
Thu May 28, 2020 9:54 pm
Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm
arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.
Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|

marcopolo
Posts: 3068
Joined: Sat Dec 03, 2016 10:22 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by marcopolo » Thu May 28, 2020 11:51 pm

typical.investor wrote:
Thu May 28, 2020 11:38 pm
marcopolo wrote:
Thu May 28, 2020 11:30 pm
typical.investor wrote:
Thu May 28, 2020 9:54 pm
Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm
arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.
Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|
It sounds like this is a convulated way of asking if index investing causes problems with price discovery.

Does not seem to have anything to do with whether the dividends are reinvested or not. The act of paying the dividend lowers their proportion in the index. Whether further investment comes from those dividends being reinvested or from new money seems irrelevant. As long as there is still price discovery, I am not sure what the concern would be about this.
Once in a while you get shown the light, in the strangest of places if you look at it right.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Fri May 29, 2020 12:08 am

JoMoney wrote:
Thu May 28, 2020 11:38 pm
typical.investor wrote:
Thu May 28, 2020 11:07 pm
... Mutual funds and ETFs hold the dividend in cash until their scheduled distribution...
That's not universally the case. Some do, some don't. In the case of index funds, the only one I'm aware of that doesn't reinvest dividends until their distribution is the SPY ETF.
OK, so if AAPL pays a 1% dividend, it's price could fall on it's Ex-Dividend Date. And dividends could be reinvested later when the money goes out on its Payable Date.

So VTSAX (Vanguard Total Stock) gets the dividend on the payable date, and what do they do? Vanguard reinvests about 4% of the dividend from Apple into Apple and about 3.75% of the dividend from Apple into Amazon per market cap weighting.

Now as to front-running, if you are going to sell AAPL on the ex-Dividend Date and before the payment date when you expect reinvestment to occur, why would anyone sell AAPL for 1% less? You know good news is coming in a few days when reinvestment happens. Why would the seller ignore that?

I very much doubt sellers are discounting AAPL by the full 1% dividend that was paid if everyone is expecting the price to go up after the payable date when the dividend is actually paid. I don't trade individual stocks, but I think you'd have to be crazy not to incorporate known news into your price. Surely traders must have numbers about how reinvestment historically has affected the price.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Fri May 29, 2020 12:21 am

marcopolo wrote:
Thu May 28, 2020 11:51 pm
typical.investor wrote:
Thu May 28, 2020 11:38 pm
marcopolo wrote:
Thu May 28, 2020 11:30 pm
typical.investor wrote:
Thu May 28, 2020 9:54 pm
Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm


1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.
Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|
It sounds like this is a convulated way of asking if index investing causes problems with price discovery.
If you are trying to twist what I am saying, sure you can twist it into that.

My simple point is that TSM reinvestment of dividends will affect the P/E of stocks differently depending on whether they are dividend payers or retain their earnings.
marcopolo wrote:
Thu May 28, 2020 11:51 pm
Does not seem to have anything to do with whether the dividends are reinvested or not. The act of paying the dividend lowers their proportion in the index. Whether further investment comes from those dividends being reinvested or from new money seems irrelevant. As long as there is still price discovery, I am not sure what the concern would be about this.
That active investors can recognize P/Es have changed, and select a price to trade based on that information is true. Surely that is how the distortion gets corrected.

From a realistic point of view though, if a trader knows that stocks which retain earnings will have their price boosted via higher valuations, many will just continue to hold that stock or buy at that price expecting prices and valuations to go higher.

The above example of the two companies clearly shows though that TSM dividend reinvestment distorts P/Es. Both companies returns 3%, yet the one that paid a dividend is now worth less due to the mechanism by which TSM reinvests. When will the distortion get corrected? One second later? One month? One year?

Value investors will tell you price and fundamentals have especially separated in the last couple years. I don't think price discovery is adjusting so quickly.

marcopolo
Posts: 3068
Joined: Sat Dec 03, 2016 10:22 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by marcopolo » Fri May 29, 2020 12:36 am

typical.investor wrote:
Fri May 29, 2020 12:21 am
marcopolo wrote:
Thu May 28, 2020 11:51 pm
typical.investor wrote:
Thu May 28, 2020 11:38 pm
marcopolo wrote:
Thu May 28, 2020 11:30 pm
typical.investor wrote:
Thu May 28, 2020 9:54 pm


I've asked this same question, and received the same answer you did.

Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|

I agree there would be a bias though.

I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.
Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|
It sounds like this is a convulated way of asking if index investing causes problems with price discovery.
If you are trying to twist what I am saying, sure you can twist it into that.

My simple point is that TSM reinvestment of dividends will affect the P/E of stocks differently depending on whether they are dividend payers or retain their earnings.
marcopolo wrote:
Thu May 28, 2020 11:51 pm
Does not seem to have anything to do with whether the dividends are reinvested or not. The act of paying the dividend lowers their proportion in the index. Whether further investment comes from those dividends being reinvested or from new money seems irrelevant. As long as there is still price discovery, I am not sure what the concern would be about this.
That active investors can recognize P/Es have changed, and select a price to trade based on that information is true. Surely that is how the distortion gets corrected.

From a realistic point of view though, if a trader knows that stocks which retain earnings will have their price boosted via higher valuations, many will just continue to hold that stock or buy at that price expecting prices and valuations to go higher.

The above example of the two companies clearly shows though that TSM dividend reinvestment distorts P/Es. Both companies returns 3%, yet the one that paid a dividend is now worth less due to the mechanism by which TSM reinvests. When will the distortion get corrected? One second later? One month? One year?

Value investors will tell you price and fundamentals have especially separated in the last couple years. I don't think price discovery is adjusting so quickly.
Again, I am not seeing how the act of re-investing has anything to do with it. Perhaps i am missing some subtlety. But, what difference is there whether the invest comes from dollars paid out as dividends from some companies, or from a periodic investment from as 401k contributions?

How companies decide to return (or not) earnings to shareholders can certainly impact how they are perceived in the market, and that may effect their P/E, growth rate, etc. But, like i said, I am still not seeing how re-investing at the new market cap ratios changes anything. The relative market caps have already been established regardless of whether you decide to re-invest it or go spend it.
Once in a while you get shown the light, in the strangest of places if you look at it right.

langlands
Posts: 260
Joined: Wed Apr 03, 2019 10:05 pm

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by langlands » Fri May 29, 2020 1:47 am

magicrat wrote:
Thu May 28, 2020 9:05 pm
Would you prefer to reinvest back into those dividend paying companies that have told you they have no use for cash?
I think this pithy rejoinder gets at the heart of the issue. No, reinvesting in the TSM with dividends does not artificially inflate one's position in growth stocks if you believe that dividend payout is done according to some form of optimal asset allocation.

A few posters seem to be comparing scenarios in which you have two identical companies, one of which pays dividends and one of which does not. And it looks like if you reinvest the dividends according to TSM, you are artificially increasing your position in the one that does not pay dividends. This is true. But the decision to pay dividends is not exogenous. There's a reason companies like Amazon and Google do not pay dividends while Ford does. If you believe in some form of efficient markets it's not possible for there to be two identical companies, only one of which pays out dividends. A company that pays out dividends is telling investors that it has no better use for the cash. A company that doesn't is telling investors it does have good use for the cash. All the dividends that get paid out are in essence "memoryless" capital. You have it because companies have decided it's better for you to have it than for them to have it. You are now free to allocate this capital as you would any other, and for many Bogleheads that is to buy the TSM.

If you believe that companies tend to pay out dividends even though they can use the cash effectively, then you should tilt your dividend payout towards those high dividend payers. But just be aware that you are in essence giving money back to a company that has told you it doesn't need it.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Fri May 29, 2020 1:50 am

marcopolo wrote:
Fri May 29, 2020 12:36 am
typical.investor wrote:
Fri May 29, 2020 12:21 am
marcopolo wrote:
Thu May 28, 2020 11:51 pm
typical.investor wrote:
Thu May 28, 2020 11:38 pm
marcopolo wrote:
Thu May 28, 2020 11:30 pm


The answer given above is that you maintain market cap weighted investment, not that your investment ratio stays the same.

By giving you the dividend, the value company has reduced their market cap (they no longer have that pile of cash sitting around). So, they now have a smaller market cap ratio then they did before hand. You can choose to buy the index at this new market cap, or not. Re-investing will maintain your investment at market cap. If you want different weighting, then you should take dividend and invest it differently. But, then why did you buy a market weighted fund in the first place?
Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.
Company A and B had the same 3% returns, yet company B now is a larger part of the index.

Has the P/E of Company B not risen and the P/E of Company A not fallen?

P/E before dividend payment:
|—————Company A 33.33—————|—————Company B 33.33—————|

P/E after dividend payment:
|—————Company A 32.83—————|—————Company B 33.84—————|
It sounds like this is a convulated way of asking if index investing causes problems with price discovery.
If you are trying to twist what I am saying, sure you can twist it into that.

My simple point is that TSM reinvestment of dividends will affect the P/E of stocks differently depending on whether they are dividend payers or retain their earnings.
marcopolo wrote:
Thu May 28, 2020 11:51 pm
Does not seem to have anything to do with whether the dividends are reinvested or not. The act of paying the dividend lowers their proportion in the index. Whether further investment comes from those dividends being reinvested or from new money seems irrelevant. As long as there is still price discovery, I am not sure what the concern would be about this.
That active investors can recognize P/Es have changed, and select a price to trade based on that information is true. Surely that is how the distortion gets corrected.

From a realistic point of view though, if a trader knows that stocks which retain earnings will have their price boosted via higher valuations, many will just continue to hold that stock or buy at that price expecting prices and valuations to go higher.

The above example of the two companies clearly shows though that TSM dividend reinvestment distorts P/Es. Both companies returns 3%, yet the one that paid a dividend is now worth less due to the mechanism by which TSM reinvests. When will the distortion get corrected? One second later? One month? One year?

Value investors will tell you price and fundamentals have especially separated in the last couple years. I don't think price discovery is adjusting so quickly.
Again, I am not seeing how the act of re-investing has anything to do with it. Perhaps i am missing some subtlety. But, what difference is there whether the invest comes from dollars paid out as dividends from some companies, or from a periodic investment from as 401k contributions?
Seriously? You don't see the P/E changing?

Ok, yeah a from your salary is totally different I think.

Company A had 3% in profits and paid out $3.
Company B had 3% in profits and paid out $3.

Company A's earnings went into both A and B per market cap weighting.
Company B's earnings went into only B as retained earnings.

Company A and B are equally profitable, it's now more expensive to buy $1 in earnings from company B and less expensive to buy $1 in earnings from company A.

So now when you make a 401k contribution from salary, you are buying more of company B (per market cap weighting) of a company that is more expensive per $1 in earnings. And you are buying less of company A which is cheaper per $1 in earnings.

Clearly, dividend reinvestment in TSM will change the relative P/Es for companies and makes company B more expensive. However, a 401k contribution won't change the relative P/Es for companies.

If you need numbers, let's say this:

A $100 purchase of TSM (A+B) before dividends (when A and B were each 50% of the market) returned $3. The total market returned $6 ($3 from A and $3 from B) and you own half the market. So you earned $3.

I am sure you are thinking so what? If I were to buy half of TSM after dividends had been reinvested when B had a larger weighting (and lower expected returns due to it's higher PE) the return be the same $3. B returns less (2.96%) and you hold more of it (50.76%) but that is made up by A returning more (3.05%). It comes out the same.

So who cares if TSM dividend reinvestment is increasing the P/E of B and lowering the P/E of A? Maybe nobody and maybe nobody should care.

Except that in the real world, some people will choose to invest only in stock B because the price is going up and looks like it is returning more than stock B (by virtue of it getting more expensive). And that will make it even more expensive. And total market investors will be ecstatic because what they hold the most of is going up the most.

I think this is where we are today with valuations at an extreme. At some point though, some investors will realize that actually just buying A is now a better deal because it simply cost less for the same earnings. And then A will do better and those holding a lot of B won't.

Anyway, the market is complicated and there are future earnings growth expectations to price in, and in reality there are many retirees choosing dividend paying stocks only as they like to spend the dividends.

I firmly believe the mechanism of TSM reinvestment will increase the P/E of non-dividend paying stocks, and that it'll be up to active traders to counteract that.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Fri May 29, 2020 1:57 am

langlands wrote:
Fri May 29, 2020 1:47 am
magicrat wrote:
Thu May 28, 2020 9:05 pm
Would you prefer to reinvest back into those dividend paying companies that have told you they have no use for cash?
I think this pithy rejoinder gets at the heart of the issue. No, reinvesting in the TSM with dividends does not artificially inflate one's position in growth stocks if you believe that dividend payout is done according to some form of optimal asset allocation.

A few posters seem to be comparing scenarios in which you have two identical companies, one of which pays dividends and one of which does not. And it looks like if you reinvest the dividends according to TSM, you are artificially increasing your position in the one that does not pay dividends. This is true. But the decision to pay dividends is not exogenous. There's a reason companies like Amazon and Google do not pay dividends while Ford does. If you believe in some form of efficient markets it's not possible for there to be two identical companies, only one of which pays out dividends. A company that pays out dividends is telling investors that it has no better use for the cash. A company that doesn't is telling investors it does have good use for the cash. All the dividends that get paid out are in essence "memoryless" capital. You have it because companies have decided it's better for you to have it than for them to have it. You are now free to allocate this capital as you would any other, and for many Bogleheads that is to buy the TSM.

If you believe that companies tend to pay out dividends even though they can use the cash effectively, then you should tilt your dividend payout towards those high dividend payers. But just be aware that you are in essence giving money back to a company that has told you it doesn't need it.
Well, the example showed two companies of equal profitability. The company that retained its earnings became more expensive. I see nothing in the example showing that company B (which retained its earnings) was any kind of optimal asset allocation.

Perhaps in the real world, the price of B would be reduced by active traders who recognize that its earnings aren't justified by the price. But that is something that will need to be corrected and that was introduced via dividend reinvestment in the TSM example.

Maybe the high P/E of Amazon is justified. Maybe not. I have no doubt though that reinvestment of dividend payers in TSM is driving it up leaving it to active traders to correct (if needed). Just because a company has a high P/E, that doesn't mean it's automatically a good investment. But having a high P/E does mean that more capital will be allocated to it than it's earnings suggest it merits.

marcopolo
Posts: 3068
Joined: Sat Dec 03, 2016 10:22 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by marcopolo » Fri May 29, 2020 2:49 am

typical.investor wrote:
Fri May 29, 2020 1:50 am
marcopolo wrote:
Fri May 29, 2020 12:36 am
typical.investor wrote:
Fri May 29, 2020 12:21 am
marcopolo wrote:
Thu May 28, 2020 11:51 pm
typical.investor wrote:
Thu May 28, 2020 11:38 pm


Yes, obviously dividend reinvestment occurs at market cap weight. That's not really the question as I see it.

Rather, the question is whether dividend reinvestment in TSM is effectively making companies that retain their earnings more expensive while making those that distribute their earnings less expensive. I believe the answer is yes. Reinvestment in TSM systematically affects P/E, and ultimately of course, passive TSMers are relying on active traders to correct things.

It sounds like this is a convulated way of asking if index investing causes problems with price discovery.
If you are trying to twist what I am saying, sure you can twist it into that.

My simple point is that TSM reinvestment of dividends will affect the P/E of stocks differently depending on whether they are dividend payers or retain their earnings.
marcopolo wrote:
Thu May 28, 2020 11:51 pm
Does not seem to have anything to do with whether the dividends are reinvested or not. The act of paying the dividend lowers their proportion in the index. Whether further investment comes from those dividends being reinvested or from new money seems irrelevant. As long as there is still price discovery, I am not sure what the concern would be about this.
That active investors can recognize P/Es have changed, and select a price to trade based on that information is true. Surely that is how the distortion gets corrected.

From a realistic point of view though, if a trader knows that stocks which retain earnings will have their price boosted via higher valuations, many will just continue to hold that stock or buy at that price expecting prices and valuations to go higher.

The above example of the two companies clearly shows though that TSM dividend reinvestment distorts P/Es. Both companies returns 3%, yet the one that paid a dividend is now worth less due to the mechanism by which TSM reinvests. When will the distortion get corrected? One second later? One month? One year?

Value investors will tell you price and fundamentals have especially separated in the last couple years. I don't think price discovery is adjusting so quickly.
Again, I am not seeing how the act of re-investing has anything to do with it. Perhaps i am missing some subtlety. But, what difference is there whether the invest comes from dollars paid out as dividends from some companies, or from a periodic investment from as 401k contributions?
Seriously? You don't see the P/E changing?

Ok, yeah a from your salary is totally different I think.

Company A had 3% in profits and paid out $3.
Company B had 3% in profits and paid out $3.

Company A's earnings went into both A and B per market cap weighting.
Company B's earnings went into only B as retained earnings.

Company A and B are equally profitable, it's now more expensive to buy $1 in earnings from company B and less expensive to buy $1 in earnings from company A.

So now when you make a 401k contribution from salary, you are buying more of company B (per market cap weighting) of a company that is more expensive per $1 in earnings. And you are buying less of company A which is cheaper per $1 in earnings.

Clearly, dividend reinvestment in TSM will change the relative P/Es for companies and makes company B more expensive. However, a 401k contribution won't change the relative P/Es for companies.

If you need numbers, let's say this:

A $100 purchase of TSM (A+B) before dividends (when A and B were each 50% of the market) returned $3. The total market returned $6 ($3 from A and $3 from B) and you own half the market. So you earned $3.

I am sure you are thinking so what? If I were to buy half of TSM after dividends had been reinvested when B had a larger weighting (and lower expected returns due to it's higher PE) the return be the same $3. B returns less (2.96%) and you hold more of it (50.76%) but that is made up by A returning more (3.05%). It comes out the same.

So who cares if TSM dividend reinvestment is increasing the P/E of B and lowering the P/E of A? Maybe nobody and maybe nobody should care.

Except that in the real world, some people will choose to invest only in stock B because the price is going up and looks like it is returning more than stock B (by virtue of it getting more expensive). And that will make it even more expensive. And total market investors will be ecstatic because what they hold the most of is going up the most.

I think this is where we are today with valuations at an extreme. At some point though, some investors will realize that actually just buying A is now a better deal because it simply cost less for the same earnings. And then A will do better and those holding a lot of B won't.

Anyway, the market is complicated and there are future earnings growth expectations to price in, and in reality there are many retirees choosing dividend paying stocks only as they like to spend the dividends.

I firmly believe the mechanism of TSM reinvestment will increase the P/E of non-dividend paying stocks, and that it'll be up to active traders to counteract that.

I think you are WAY over thinking this.

Money is fungible (you do agree with that, right?)

Once a dividend is paid, you have that money in your hands.
You also get some money from your salary. You have that in your hand.

The market can't tell the difference between the two.

How can investing the money from your salary possibly have a different impact than investing the money from your dividends?!?

Using actual dollars. Let's say you get $1000 dollars in dividends from an index fund. At the same time you get paid your salary of say $3000. So, now you have a total of $4000. You have bills to pay that total $3000,. After paying those bills, you have $1000 dollars left over. So, you decide to invest it into the same index fund. How will the fund or the market know whether that $1000 came from your salary or from your dividend? The answer is they can't, because money is fungible.

re-investing dividends can not have any different impact than investing any other dollars. its all just money.
Once in a while you get shown the light, in the strangest of places if you look at it right.

User avatar
Schlabba
Posts: 538
Joined: Sat May 11, 2019 9:14 am
Location: Netherlands

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by Schlabba » Fri May 29, 2020 3:54 am

typical.investor wrote:
Fri May 29, 2020 1:57 am
langlands wrote:
Fri May 29, 2020 1:47 am
magicrat wrote:
Thu May 28, 2020 9:05 pm
Would you prefer to reinvest back into those dividend paying companies that have told you they have no use for cash?
I think this pithy rejoinder gets at the heart of the issue. No, reinvesting in the TSM with dividends does not artificially inflate one's position in growth stocks if you believe that dividend payout is done according to some form of optimal asset allocation.

A few posters seem to be comparing scenarios in which you have two identical companies, one of which pays dividends and one of which does not. And it looks like if you reinvest the dividends according to TSM, you are artificially increasing your position in the one that does not pay dividends. This is true. But the decision to pay dividends is not exogenous. There's a reason companies like Amazon and Google do not pay dividends while Ford does. If you believe in some form of efficient markets it's not possible for there to be two identical companies, only one of which pays out dividends. A company that pays out dividends is telling investors that it has no better use for the cash. A company that doesn't is telling investors it does have good use for the cash. All the dividends that get paid out are in essence "memoryless" capital. You have it because companies have decided it's better for you to have it than for them to have it. You are now free to allocate this capital as you would any other, and for many Bogleheads that is to buy the TSM.

If you believe that companies tend to pay out dividends even though they can use the cash effectively, then you should tilt your dividend payout towards those high dividend payers. But just be aware that you are in essence giving money back to a company that has told you it doesn't need it.
Well, the example showed two companies of equal profitability. The company that retained its earnings became more expensive. I see nothing in the example showing that company B (which retained its earnings) was any kind of optimal asset allocation.

Perhaps in the real world, the price of B would be reduced by active traders who recognize that its earnings aren't justified by the price. But that is something that will need to be corrected and that was introduced via dividend reinvestment in the TSM example.

Maybe the high P/E of Amazon is justified. Maybe not. I have no doubt though that reinvestment of dividend payers in TSM is driving it up leaving it to active traders to correct (if needed). Just because a company has a high P/E, that doesn't mean it's automatically a good investment. But having a high P/E does mean that more capital will be allocated to it than it's earnings suggest it merits.
The dividends reduce the market cap of the dividend paying company. When you invest again you invest at the new market cap weights.

There is nothing artificial about it. No active traders needed to "correct" such market events.
Secretly a dividend investor. Feel free to ask why.

typical.investor
Posts: 2038
Joined: Mon Jun 11, 2018 3:17 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by typical.investor » Fri May 29, 2020 7:37 am

Schlabba wrote:
Fri May 29, 2020 3:54 am
typical.investor wrote:
Fri May 29, 2020 1:57 am
langlands wrote:
Fri May 29, 2020 1:47 am
magicrat wrote:
Thu May 28, 2020 9:05 pm
Would you prefer to reinvest back into those dividend paying companies that have told you they have no use for cash?
I think this pithy rejoinder gets at the heart of the issue. No, reinvesting in the TSM with dividends does not artificially inflate one's position in growth stocks if you believe that dividend payout is done according to some form of optimal asset allocation.

A few posters seem to be comparing scenarios in which you have two identical companies, one of which pays dividends and one of which does not. And it looks like if you reinvest the dividends according to TSM, you are artificially increasing your position in the one that does not pay dividends. This is true. But the decision to pay dividends is not exogenous. There's a reason companies like Amazon and Google do not pay dividends while Ford does. If you believe in some form of efficient markets it's not possible for there to be two identical companies, only one of which pays out dividends. A company that pays out dividends is telling investors that it has no better use for the cash. A company that doesn't is telling investors it does have good use for the cash. All the dividends that get paid out are in essence "memoryless" capital. You have it because companies have decided it's better for you to have it than for them to have it. You are now free to allocate this capital as you would any other, and for many Bogleheads that is to buy the TSM.

If you believe that companies tend to pay out dividends even though they can use the cash effectively, then you should tilt your dividend payout towards those high dividend payers. But just be aware that you are in essence giving money back to a company that has told you it doesn't need it.
Well, the example showed two companies of equal profitability. The company that retained its earnings became more expensive. I see nothing in the example showing that company B (which retained its earnings) was any kind of optimal asset allocation.

Perhaps in the real world, the price of B would be reduced by active traders who recognize that its earnings aren't justified by the price. But that is something that will need to be corrected and that was introduced via dividend reinvestment in the TSM example.

Maybe the high P/E of Amazon is justified. Maybe not. I have no doubt though that reinvestment of dividend payers in TSM is driving it up leaving it to active traders to correct (if needed). Just because a company has a high P/E, that doesn't mean it's automatically a good investment. But having a high P/E does mean that more capital will be allocated to it than it's earnings suggest it merits.
The dividends reduce the market cap of the dividend paying company. When you invest again you invest at the new market cap weights.

There is nothing artificial about it. No active traders needed to "correct" such market events.
Naw, you are missing something. So am I. Price discovery needs to happen on the reinvested shares. After all they have to come from someplace.

1) Before dividend payment:
|—————Company A $100—————|—————Company B $100—————|
|—————Company A 50% —————|—————Company B 50% —————|***

2*) After dividend payment, before reinvesting dividends:
|———Company A $100 ———|———Company B $103———|—Cash $3 —|
|———Company A 48.5%———|———Company B 50% ———|—Cash 1.5%—|

2.5) Price discovery must occur here on the shares. Someone has to be selling them for TSM to purchase more. I guess it's logical to assume that if A and B are equally profitable companies, that a seller would ask for the same price as B (risk being equal). Especially if they know what we do ... namely that both companies will return $3 in profits.

3) After reinvesting dividends
|—————Company A $103 ————|—————Company B $103—————|
|—————Company A 50%—————|—————Company B 50%—————|

So I adjust my assertion that TSM is changing P/Es in dividend reinvestment, to the assertion that dividend reinvestment in TSM requires active investors doing correct price discovery.

Thus I conclude that if the active investors favor growth (as they often do in the short run), then dividend reinvestment in TSM can be a mechanism by which active trader preferences affect price, market-capitalization and P/E ratios.

* I changed 2 because probably in 1 both companies are worth $100. After running for some time they generate $3 in profits.

*** the 50% A/B split isn't realistic as it wouldn't allow for additional shares to be bought in dividend reinvestment, but I left it in

User avatar
Topic Author
Nicolas Perrault
Posts: 209
Joined: Thu Sep 27, 2018 12:33 pm
Location: Oxford, UK

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by Nicolas Perrault » Fri May 29, 2020 9:59 pm

typical.investor wrote:
Thu May 28, 2020 9:54 pm
Nicolas Perrault wrote:
Thu May 28, 2020 9:10 pm
arcticpineapplecorp. wrote:
Thu May 28, 2020 8:58 pm

You end with market cap, same as you started before the dividend was paid, no?
1) Before dividend payment:
|—————Value $100—————|—————Growth $100—————|
|—————Value 50% —————|—————Growth 50% —————|

2) After dividend payment, before reinvesting dividends:
|———Value $97 ———|———Growth $100———|—Cash $3 —|
|———Value 48.5%———|———Growth 50% ———|—Cash 1.5%—|

3) After reinvesting dividends
|—————Value $98.5 ————|—————Growth $101.5—————|
|—————Value 49.25%—————|—————Growth 50.75%—————|
<— Bias toward growth created by difference in dividend payout ratios.
I've asked this same question, and received the same answer you did.
May I get a link?
typical.investor wrote:
Thu May 28, 2020 9:54 pm
Anyway, you have a nice example to counter that answer. Can I nitpick your values though? I don't think you can allocate 50% of dividend reinvestment to value. You can only allocate 49.25%. So:

3) After reinvesting dividends
|—————Value $98.48 ————|—————Growth $101.52—————|
|—————Value 49.24%—————|—————Growth 50.76%—————|
Good eye, thanks for catching that :beer
typical.investor wrote:
Thu May 28, 2020 9:54 pm
I guess you'd have to expect active traders to come along and recognize that the P/E of growth is too high and the P/E of value is too low. Given that future earnings is a little difficult to predict, maybe it wouldn't happen so accurately or right away.
What if one bought all stocks in the TSM individually according to market weight and then re-invested the dividends of each stock into itself? Whenever a new company becomes public, you sell shares of old companies to buy the shares of new ones. What would this portfolio look like in the long run? How different from market weight would this portfolio be today if assembled in 1871 and held to the present? How warped a portfolio would you have?

Would you hold 70% railroad stocks or something? (I'm joking)

Patzer
Posts: 271
Joined: Wed Jun 10, 2015 10:56 am

Re: Does reinvesting TSM dividends artificially inflate one’s position in growth stocks?

Post by Patzer » Fri May 29, 2020 10:48 pm

typical.investor wrote:
Fri May 29, 2020 1:50 am

Company A and B are equally profitable, it's now more expensive to buy $1 in earnings from company B and less expensive to buy $1 in earnings from company A.
You argument is compelling, but flawed.

The flaw in your logic is that their earnings don't stay the same.
The value company pays out more of it's earnings, so it's earning grow more slowly, since less cash is reinvested in the business.
The growth company doesn't just put the $3 it didn't pay out in earnings under the mattress. Instead, it reinvests it in the business, which makes it's earnings grow faster (hence the term growth company).

The act of the value company paying out dividends is what causes value to become less of the index, not the act of reinvesting the dividends at market weight. If you spent that money on beer instead of reinvesting it, the value companies would still be worth less than the growth after the dividend pays out.

So, over infinite time you could take this argument to conclude that the index will become 100% growth, but that is also wrong.
It is wrong, because the bigger growth companies get, the more market share they have, and the less growth they anticipate from reinvesting their earnings, so they start to pay more and more dividends, and turn into value companies.

Post Reply