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Question:
Martin Gomez holds 100 shares of each of the stocks in a price-weighted index and reinvests cash dividends in additional shares. Assuming there are no stock splits, stock dividends, or changes in the makeup of the index, how will Gomez’s portfolio return compare with the price return of the index if the low-priced index stocks outperform the high-priced index stocks?
A
Gomez’s portfolio return will be higher.
explanation
The price return on the index does not include cash dividends. Since the reinvested dividends will add to the number of shares of those stocks that pay dividends, Gomez’s portfolio return (total return) will be higher than the price return on the index. The relative performance of high-priced and low-priced stocks does not affect this result.
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