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Another_Saver

bowlhead99 said:

Another_Saver said:

bowlhead99 said:

Another_Saver said:
and just like in the other thread (https://forums.moneysavingexpert.com/discussion/6206301/vvfusi-or-vmid#latest)@bowlhead99 seems to have gone quiet once proved wrong.

I did explain why I hadn't spent the time to reply to your four posts in a row on that other thread, although some of the content was picked up within this one, so no great loss other than your ego being a bit bruised from feeling you were being ignored over there.

On this one, the fact I haven't kept up with your frenetic pace of posting 16 posts on a single beginner's thread within 24 hours shouldn't be taken as an inference that I've 'gone quiet' - simply that most people don't have time to keep up with your persistence to the cause. FWIW it doesn't seem that I've actually been 'proved wrong' about anything at all; each of my paragraphs are fine in their context.

HTH

Do you have something to add?

bowlhead99 contends on various threads that companies issuing shares essentially does not affect existing shareholders (on aggregate). Perhaps the Investopedia page on share dilution would be useful (https://www.investopedia.com/articles/stocks/11/dangers-of-stock-dilution.asp).

I do know what share dilution is thanks. Clearly a company issuing shares to new investors, or more shares to certain existing investors, dilutes existing owners of the shares who will now own a smaller piece of the pie when it comes to divvying up the profits. I don't know where I've ‘contended on various threads’ that this is not the case. 

Of course, most companies don't do this just for fun, because investors would be unhappy and not sanction it. The reasons for dilution are often positive - for example to fund investment and expansion, which enhances or maintains total earnings for each investor, because the overall profits rise. Or the company is raising money because it needs capital to stave off failure or regulatory sanction, so it is better to do it than not do it, as in its absence the profits per share would fall and the company could fail, while after the dilution they fall less far (so less loss per share) and the company doesn't fail. Whether the fundraise event is long-term accretive for existing shareholders depends on the circumstances, but when looking at it in the context of individual companies (rather than an index of companies) we can generally presume shareholders would prefer not to let too much of it happen if it was going to be too bad for their interests.

bowlhead99's argument seems to be that, as there is no direct loss or cost to existing shareholders, and since it is a means of raising capital to generate earnings, dilution within an index such as the FTSE 100 should not be thought of as causing the aggregate shareholder's returns per share to lag the aggregate returns by the extent of dilution, explaining the point by analogy and hypothetical scenarios. Does anyone else has a simpler way of explaining this?

If the FTSE100 companies valued at £1500bn between them were going to make £100bn profits between them and a new IPO rocks up - Maverick Industries - whose value is £30bn higher than the company it displaces and prospective profits are £2bn higher than the company it displaces, it will take a seat at the FTSE table and the total value of the FTSE100 companies will go up to  £1530bn and total profits will go up to £102bn.  The FTSE index figure of say 10,000 is unchanged by this event.

Investors will adjust their holdings as necessary, perhaps acquiring shares in newco by swapping out some of their shares in oldcos. Overall, the enlarged investor community (or perhaps the same exact investors but more capital at risk per person, depending who funded the IPO) will have access to the £102bn profits that will be made, which supports the £1530bn valuation of the collective. It is true that the ownership by the ‘old money’ – the profits share represented by the pile of old share certificates – has been diluted down to be only 1500/1530ths of the total and will only get 100/102ths of the profit, but that is not necessarily an issue per se, because they are still getting the 100 they were going to get previously.

Assuming P/E ratios stay the same: if all the companies in the new index are successful the next year they may each grow their profits by 10%, causing them to all be valued at a new value of 1530+153= 1683. The index would rise by 10% from its previous value when the market cap was 1530 (to be 11000 instead of 10000), but in total the market cap would have risen from 1500 to 1683 which is 12.2%.  So as an observer you would say there has been some ‘dilution’ because you can see the market cap growth is more than the index growth, but everyone has still made the same return they would have made in the absence of the new entrant. 

The aggregate ‘returns per share’ of 10% is still just as good as the aggregate growth made by the constituents together (10% profits growth and 10% growth in valuation of each of the companies).  All the new and old capital has made the same returns. The amount of capital being monitored in the index has gone up by a greater percentage than that, because new money came in from the outside (from investors bank accounts, or from the sale of other asset classes such as bonds or private equity holdings etc, or from a Russian oligarch), but it didn’t make investors worse off.  Of course the old investors didn't take all the old and new profits, only the old proportion of the total profits, but they would have been welcome to use their own resources to buy in to the IPO for a greater proportion of the total pie if they had wanted their capital to make that extra return rather than someone else's capital to make that extra return.

Alternatively, perhaps the new entrant is really successful because his efficient new international operation flying rubber dogs out of Hong Kong grows its profits by 20% while all the other companies only grew 10%. If that is recognised in company valuations the total value of the companies in aggregate would now be (30+6+1500+150=1686 instead of 30+3+1500+150). The 1686 represents a 10.2% increase in the 1530 from the start of the year, so the index goes up from 10000 to 11020 instead of 11000. The extra 0.2% growth came from the fact that 2% of the index delivered an extra 10% growth than the rest of the index.     

In that scenario of course we still end up with the market cap growing faster than the index (1686 from 1500 is 12.4% market cap growth compared to 10.2% performance index growth) so there was still evidently ‘dilution’ if the old investor set chooses not to introduce more capital and participate in the IPO fundraise themselves, but the index investors (who take a proportionate interest in all companies in the index) will make 10.2% profits, which is more profit than they would have made sans dilution. 

The performance increase they experienced came from admitting the new profitable FTSE100 constituent, but the same effect would have been felt if we were talking about one of the existing FTSE100 companies doing a capital fundraising to issue new shares to fund the lucrative airfreight business which delivered the extra annual profit.

I assume your objection to my saying ‘this is not an issue’ is that your base assumption was that an index can’t grow faster than GDP and so any profits that could be made by the index of companies would be constrained by the fact that there’s only so much profit to go around... so if the ‘old investors’ have their percentage ownership of the index diluted by more capital (marketcap goes up faster than performance), they are destined to make less money than they were going to. However if the new company does not ‘steal profits’ from the existing companies, it is not really a closed system and the total amount of company valuation or annual profits represented by an index can and does freely float as a ratio to GDP for decades. It's obvious that if you allow someone else's capital to participate alongside yours in a market you will not personally make all the profits in the index, but you can still make the same percentage return on your money as you were going to, as long as the total profits made by the index can rise.

For example, the revenues or profits to be made by Unilever are not limited to UK GDP growth but by the size of the South Asian or West African appetite for branded consumer products which can grow at a much higher rate. If investors in an index are ‘diluted’ by issuing shares of growth companies such as Ocado or Amazon or Boohoo or Morningstar Inc, they will get exposure to the profits from those companies, but they will not necessarily lose their existing profits to make way for it, because the revenues made by those expanding companies are revenues that were formerly made by BHS or Ikea or John Lewis or Matalan or FE Fundinfo who were not in the index anyway because of being private companies. 

I have already listed the numerous caveats that apply to my point, including globalisation.

Basically you have a neat formula to ‘prove’ the make up of a valuation or market cap figure which only works if a whole load of assumptions hold true which in the real world will pretty often not hold true.

If I dare to mention why the assumptions you rely on for your model calculation may be flawed or not hold true, you would take it as an affront to your diligence, but you are happy to say yourself that everything needs to be caveated up the wazoo.

From your perspective, your model is spot on, though  you acknowledged that it was only spot on to the extent of caveats for factors that can’t be easily predicted or quantified, so you don’t really know to what extent it is spot on; as you mention, academics have noted there are “numerous factors that can pull returns away from GDP over an investing lifetime” and that you, “have also explained that all the other factors that affect the market can cancel out capital dilution over an investing lifetime”, and that corporate profits can grow or shrink relative to GDP over long periods with the only boundary being that such periods must be “finite” rather than infinite, and a variety of other caveats you mentioned.

 

And yes, I have noticed your arguments keep changing slightly from post to post - you don't have to do that when you know you're right.

-It would be quite boring if every thread used the same exact text to explain a point and two commenters just repeated their last posts verbatim until one got bored. So forgive me if I sometimes use different words to explain the point of view, which is not the same as 'changes his argument'; merely wondering which words may help it to 'click' with its reader.

I give up, I have never met anyone as persistent and stubborn about being corrected. Just to use your Unilever example, Unilever cannot freely sell to new markets at the same costs as to existing markets. Entering a new market is itself a capital investment - research, logistics, politics, trade terms, wholesalers, distributors, manufacturing, networks & connections, staff, local offices, local laws & regulations, import routes, insurance, translation, security, the text on the packaging, the language of the text on the packaging, perhaps being required to manufacture in country in which case factories, sourcing a site, labour, local politics/laws/Regulations, construction, utilities, getting raw materials to the new site...

My original point back when I mentioned this in the previous thread was wandering about the future - will past trends continue, will Arnott & Bernstein's observation about capital dilution even make sense given today's higher global ownership and global sales ratios across developed markets? On aggregate at a global level, probably yes, but is the UK a sufficiently small subsection of the global market for other factors to come into play? For the FTSE 250 at least, I think yes. The profits from acquisitions of 250 co's from capital sources outside the 250 index give a 250 index fund free inflows to buy the replacements with. For me it's an active investment decision made as per the reasoning I have given.
I only wish a 250 ex-ITs fund was available for less than VMID.

Edit: it's worrying how folks in this forum give more weight to a so-called heavyweight's vague wafflings than mathematical verities, textbook capitalism and academic expertise.

MaxiRobriguez

Both of your input is valid, useful and entertaining. You can disagree, it's fine. Move on, for both of your sakes!