Trading & the Zero Sum Game Debate
- Thread starter butterfacetrader
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I had to sign up because the question has always bothered me. I have to conclude that it is not a zero sum game when accounting for dividends. Overall wealth of the traders can grow because it can come from productivity in the real world. The productivity rewards the stock holders in the form of dividends.
If all stocks did not pay dividends then I would conclude the game is zero sum. The total wealth of traders will only increase from money contributed by new traders.
If all stocks did not pay dividends then I would conclude the game is zero sum. The total wealth of traders will only increase from money contributed by new traders.
This is not true. A dividend simply distributes cash flow and comes out of the stock price. You are a dollar richer in dividend and a dollar poorer in equity. Stocks that don't pay dividends have to offer a discount equal to the dividend to compensate investors for the same future periodic cash flows Ceteris paribus.
It is not necessary that stock prices reflect the discounted cash flow though. The prices simply reflect the supply and demand in the stock market, no? Anything else is coincidental. The buyer's wealth can increase overall assuming he buys an undervalued stock. Since the stock market is not perfectly efficient and humans are not perfectly rational, I believe my non zero sum assumption applies when dividends come into play.
Edit: I forgot to include the seller's wealth as well! If we include the gains from the seller, the losses from the buyer, and the dividends to the buyer, then it is very easy to see that the sum does not equal zero.
It doesn't matter if the stock price is actually "reflecting" the discount. Overtime the discount is used for valuation purposes. Google DCF. It stands for dividend discount model. Getting a dividend has nothing to do with zero sum. I'm not sure what your background is but this is discussed and modeled endlessly in most any college finance program. Let me further add that many models actually penalize the dividend model! The reason is the tax treatment of the dividend. The dividend generates a short term gain which is taxed at the high marginal tax rate. A long term holder actually captures this amount over time. Meaning there is a deadweight loss to the short term investor which he/she forgoes to receive the cash flow today vs in the future. This is also analyzed endlessly. There is nothing new here.
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another."
I am but a lowly learner of stock trading. You speak of models that I'm not yet familiar but I'm simply looking at the game from a monetary perspective. Forget about all the details of taxes, expectations, and commissions. Person A gives Person B $100 for a share. Person A gets $5 from dividends later on. The sum of money has increased to $105. So how can the game be zero sum? That's all I'm arguing and maybe I'm misunderstanding something here.
Where are you getting 105 from? Person A gets $5 in dividends tomorrow and the stock price drops by the same amount. It's now a $95 stock. Your account equity drops by that amount. Your cash account goes up by 5. The net sum is ZERO! How are you getting this "extra" $5 for free. How do you think companies pay for their dividends? It comes out of their stock.