Dividend versus Growth

A recent web article compared a total return from 1960 to 1999. A table showed the S&P 500 average annual total return was 12.5% (3.4% in dividends [27.9% of the total] and 9.1% in capital gains). Using the old Dividend-Bond Multiple Rule (via hypothetical market prices based on 120% dividend-bond yield multiples), the annual returns in the same period would have been 17.5% (9.7% in dividends (55.1% of the total) and 7.8% in capital gains. The table showed that investors would have had higher total return and better downside protection with dividends as part of their investing program.

Gradually, particularly among seasoned investment analysts and some academicians, Williams’ valuation theories gained credence. Arnold Bernhard, founder of “The Value-Line Investment Survey,” quoted Williams’ book, The Evaluation of Common Stocks:

“Williams postulates that the value of a stock is the sum of all its future dividends discounted by the present interest rates. . . . Because there is no generally accepted standard of value, the market prices of stocks fluctuate far more widely than their true values. The wide fluctuations have in the past imposed a heavy burden on the general economy and undermined the faith of many people in the free market economy. The need, therefore, exists for rational and disciplined standards of value that cannot lead to the wildness of 1929 or 1949 or the present.”

Arnold Bernhard also boldly stated, “In our own experience, during periods of inflation as well as at other times, in this country and abroad, it has been found that dividend-paying ability is the final determinant of the price of a common stock.  Over a period of years, whenever the dividend or the company’s ability to pay dividends, went up; so too did the price of the stock.  When the dividend-paying ability went down, so did the price of the stock, inflation or deflation.”

As an affirmation of Williams’ theories about intrinsic value and speculation, let’s look at the Great Recession of 2008-2009. From peak to trough, both price and earnings of the Dow Jones Industrial Average fell by just over 50%, while dividends fell by only about 15%.

In his 1959 book, Dividends, Earnings, and Stocks Prices, Myron Gordon pays tribute to Mr. Williams for his pioneering work in discovering methods of calculating the intrinsic value using the dividend.  Mr. Gordon would later win a Nobel Prize for his expansion of John Burr Williams’ groundbreaking work.  Many academics and investment professionals believe that Mr. Williams’ work also deserved a Nobel prize.
Williams extolled the virtues of a long-term view of the investment markets. He believed profitable investing focused on the long-term growth rate of dividends.  How right he was.  Since 1960, the annual price growth of the Dow Jones Industrials has averaged about 5.9%.  That figure is remarkably similar to the average annual growth rate of dividends of near 5.6%.  While these growth rates are very similar, they do not move in tandem.  Dividend growth over the years has been consistent, while stock price growth has been very volatile.  On average every two to three years they converge.

Market volatility can be frightening for, but long-term dividend investors should celebrate it. Large discrepancies between prices and dividends signal buying or selling.  In 1938, John Burr Williams predicted prices and dividends will always converge. Long-term investors who focus on dividends can avoid market ups and downs and even profit from it.

By claiming dividends, rather than earnings, were the determining factor in calculating intrinsic value, Williams knew he was reversing the normal rule that every new investor learns.  Williams said, “The apparent contradiction is easily answered, however, for we are discussing permanent investment, and not speculative trading; and dividends for years to come, not income for the moment only.”

John Burr Williams struck a bright line between being in the chicken business and being in the egg business.  He believed that buying and selling chickens was a commodity decision and thus, speculation.  On the other hand, investing in egg-laying chickens was completely different.  It was possible to calculate the present value of a chicken by estimating its total egg-laying potential during its lifetime and then discounting it to a present value.



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