The Magnificent 7 Stocks Are Getting A Big Boost From An Unexpected Source

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• Mega-cap tech stocks have been getting a boost from dividend reinvestment, BofA says.
• Smaller firms pay more dividends but receive less reinvestment than tech giants.
• The trend is exacerbated by the continued rise of passive investing and market-cap-weighted ETFs.

An overlooked dynamic has been helping fuel the continued dominance of mega-cap technology stocks.

Bank of America highlighted on Wednesday that dividend-paying stocks in S&P 500 are inadvertently diverting their own cash to the largest companies in the benchmark index.

The bank found that because of the extreme concentration in today's stock market and the fact that mega-cap tech stocks pay very little in dividends themselves, they're benefiting at the expense of smaller firms that do pay their investors dividends.

For every $100 in dividends paid by and reinvested in the S&P 500, the bottom 493 companies in the index contribute $94 in dividends but receive just $68 during the reinvestment phase.

Conversely, the Magnificent 7 stocks contribute just $6 in dividends but receive $32 during the reinvestment phase.

"Mega caps account for just 6 cents of every dividend dollar but receive 5x that in reinvestment," Bank of America said.

Bank of America

Even large-cap companies that do pay dividends, like Apple and Alphabet, see a tailwind from this effect.

Apple's dividend yield is around 0.4%, while Alphabet's is about 0.3%. That's well below the 3% yield seen in traditional dividend-heavy sectors like utilities or consumer staples and below the S&P 500's dividend yield of about 1.2%. Yet, these tech giants still benefit from the reinvestment on a larger scale than small firms.

This dynamic is exacerbated by the rise of passive investing, with trillions of dollars staked to the underlying S&P 500 index.

About 54% of total equity fund assets are invested in passive strategies, compared to 46% for actively managed strategies. According to the bank, market-cap-weighted funds continue to dominate the ETF market, controlling 68% of that market share.

The continued rise of passive investing has led to "less focus on fundamentals" by investors, Bank of America said, which further enables the redirection of cash dividends from smaller-sized companies to larger-sized companies.

"Because passive investing is less sensitive to valuation and other fundamentals, some market participants worry that passive funds make markets less efficient. And since most passive funds are weighted by market-capitalization, passive flows can exacerbate market concentration, thereby reducing diversification," BofA said.