[mixedbit]

Could outperformance of largest cap companies be partially explained by dividends paid by smaller caps? Reasoning behind this:

* Index investing raises in popularity, with index funds that automatically reinvest dividends being often preferred due to their tax efficiency.

* Large caps prefer to repurchase stocks, stock repurchases contribute fully towards a given company share price increase.

* Smaller caps still pay dividends, these dividends are then reinvested by index funds and the reinvestment is weighted by capitalization, so large caps share price benefits more from repurchases done with dividend cash paid by smaller caps. When dividend is paid, share price of a company that paid it is reduced, which further widens the performance gap between large and smaller caps.

[redwood]

It is not accurate to say that reinvesting dividends offers tax efficiency. Dividends are generally taxed in year whereas capital gains are only paid when an equity is sold. I think what you're actually referring to is a slightly different phenomenon which is that index ETFs have this handy ability to rebalance funds between stocks in the index in a way that doesn't itself lead to capital gains taxes and this is a definite tax advantage of ETFs.

Anyway I just wanted to call out that Dividends are considered tax inefficient which is why stock buy backs became popular

[semanticc]

That's not an effect. As both in the case of a dividedend and a stock buy back, the company's market cap drops by the amount of cash that's being distributed out, creating an identical re-buying situation in market cap-weighted index funds. Stock price itself is irrelevant for index fund rebalances (unlike for shareholder returns).

[gruez]

>* Large caps prefer to repurchase stocks, stock repurchases contribute fully towards a given company share price increase.

That doesn't work because indices are typically market cap weighted. A stock buyback might increase nominal stock prices, but not the market cap, otherwise it'd be a free money machine.

[mixedbit]

You are right, but if stock repurchase does not increase market cap, dividend payment still decreases it (unless it would be fully reinvested in the same stock, which it is not, it is largely reinvested in largest caps).