Question

Two stocks are both priced at $75 in the market today. One has paid a dividend for years and is expected to continue to do so for a long time. The other pays no dividend and there is no expectation of a dividend being paid any time soon. What could explain the price being the same when one h­as the dividend and the other does not?

Answer 1

The concept of Homemade Arbitrage can explain the share price of the two stocks being the same. The investors in share not paying dividend can replicate the dividends by selling part of the shares which give the same income as the other share.

This is as per Modigliani Miller theory of Dividend Irrelevance. The Ultimate portfolio value at any point of time will remain the same as the share not paying dividend will increase in price, thus offsetting the loss of shares sold for dividend purpose.