Month: February 2018

More T.  Rowe Price Quotes

 

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”

 

“Buy stocks of growing businesses, managed by people of vision, who understand significant social and economic trends and who are preparing for the future through intelligent R&D.”

 

“It is better to be early than too late in recognizing the passing of one era, the waning of old investment favorites and the advent of a new era affording new opportunities for the investor.”

 

“No one can see ahead three years, let alone five or ten. Competition, new inventions – all kinds of things – can change the situation in twelve months.”

 

Buying obscure or out-of-favor growth stocks is a very reliable recipe for making money in the market.

“If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall, and long before Wall Street discovers them.”

 

“Insurance companies know that a greater risk is involved in insuring the life of a man 50 years old than a man 25 and that a much greater risk is involved in insuring a man of 75 than one of 50. They know, in other words, that risk increases as a man reaches maturity and starts to decline…”

 

“In very much the same way, common sense tells us that an investment in a business affords great gain possibilities and involves less risk of loss while the long-term, or secular, earnings trend is still growing than after it has reached maturity and starts to decline… The risk factor increases when maturity is reached and decadence begins…”

 

Buying and Selling Tips from T. Rowe Price

 

How to Buy

 

1. Look for a record of increasing earnings

 

2. The best time to buy growth stocks is when they are out of favor.

 

3. Buy stocks with a record of rising dividends. They are worth a higher multiple than secondary stocks.

 

4. Stable growth is worth more than cyclical growth. Cyclical stocks deserve a higher multiple of their recession earnings than of their peak earnings.

 

5. Investors should pay a lower multiple for earnings for growth stocks when bonds hav high yields.

 

6. When stocks are yielding 5% or more, investors should pay a lower p-e ratio for growth stocks than when the growth stocks are yielding 3% or less. The “total return” of growth stocks have to copete with bonds or other stocks.

 

Scale Buying: When a growth stock falls to its target price, buy aggressively and not worry about bottom fishing.

 

How to Sell

 

Price said an investor had to be able to tell when a company’s earnings growth is ending. Ways of doing that would be to watch for:

 

1. Decreasing sales

 

1. Declining earnings and profit margins over several quarters

 

1. Lower return on invested capital for several quarters

 

1. Sharply increasing taxes and detrimental regulations or unfavorable court decisions

 

1. Negative changes in management

 

1. Saturation of markets/increasing competition

 

1. Substantial increases in cost of raw materials and labor.

 

Scale selling: Price waited until a stock had risen 30% over its upper buying limit. After that, he sold 10% of his position and after that, he sold 10% more when the price rose another 10%. He would sell sooner if a bull markets topped out or if the stock was falling because of bad news from the company.                                                        

 

 

Crowd Psychology and Crises

 

Edson Gould felt his most important discovery was “the action of the stock market is nothing neither more nor less a manifestation of mass crowd psychology in action.”

Gould made his discovery in Gustave Le Bon’s 1895 book, The Crowd: A Study of the Popular Mind Le Bon (1841-1931), a French social psychologist, sociologist and physicist, also wrote about anthropology and archaeology. His ideas influenced many people including, Hitler. A few of his ideas were proven false, but they are still taught today.     Le Bon wrote about psychology that created financial havoc over the centuries.

Other writers wrote about the financial havoc that psychology helped to cause:

 

• In 1841, John Mackay (1814-1889), a Scottish journalist and accomplished teller of stories, wrote Extraordinary Popular Delusions and the Madness of Crowds. He wrote about early bubbles or financial manias like the South Sea Company bubble of 1711-1720, the Mississippi Company bubble of 1719-1720 and the Dutch tulip mania of the early 17^th century.

 

• In 1978, economic historian Charles Poor Kindleberger, II (1910-2003), and Robert Z. Aliber wrote Manias, Panics and Crashes-A History of Financial Crises. This tome describes the history of financial money and credit mismanagement and lessons learned.

 

• In 1933, Robert L. Smitley (1881-1964), a bookstore owner on Wall Street, became an expert on investor psychology, wrote Popular Financial Delusions. Robert explored investors’ common delusions and misconceptions.

One of Smitley lectures was, “An abstract of the Known Histories of Polybius Written about 170 B.C.” It compared investors’ abstractions with modern conditions and pointed out fundamentals to show how little fundamentals have changed in the last 2100 years.

 

• In 1902, Financial Crises and Periods of Industrial and Commercial Depression, written by Theodore E. Burton (1851-1929), U.S. Senator from Ohio and co-sponsor of the Sherman Anti-Trust Act. The book was written before the Federal Reserve existed and events of the 1930s.

This issue is a snapshot of investment psychology, crises, manias and delusions. We can see that there is nothing new when human nature is involved and it would be wise to learn from history rather than think new is always better. If we choose to do so, we can profit from history’s mistakes.

 

Causes of Crises

 

Let’s look at the most strongly advocated theories, and those that have the largest degrees of truth:

 

1. Lack of confidence
2. The abuse or undue extension of credit (by excessive bank credits or by inflated currency issues
3. The readjustment of conditions resulting from inevitable changes in values or prices
4. A general fall in prices
5. General changes in prices resulting from changes in the monetary unit
6. Contraction of the circulating medium or insufficient volume on money
7. Over-production or under-consumption
8. Psychological tendencies – the mental and moral disposition of mankind.

 

“Some of the above influences may create a derangement, which may directly cause a panic or crash. Indirectly it may cause a more serious and permanent condition known as a depression (aka recession).

Depression/recession may be greatly intensified by some or all of these influences. The central fact in all depressions/recessions, as well as in those crises followed by depressions, is the condition of capital. These disturbances are due to derangements in condition, which can take the form of waste (or excessive loss of capital or its absorption), to an exceptional degree, in enterprise not immediately remunerative. In some form waste, excessive loss, or absorption, is the real cause. Others may say that crises and depressions/recessions are due to misdirection of productive energy.”

Excerpts from Popular Financial Delusions, by Robert L. Smitley

 

• “The destiny of nations is governed by psychological Influences and economic necessities.”

 

• “…we cannot go back to a currency era without massive upheavals. The cause of the great boom was credit expansion to an abnormal degree-the same cause as that for all booms under a credit system.”

 

• “Possibly the easiest act for any human being is to spend money, which does not belong to him.” The only easier activity is lending money that is not yours and earning a yield on either the profit or loss. Almost anyone will risk funds in an enterprise when the funds are not his own.”

 

• “The great universities find that when their outstanding economic teachers are called into the business arena, the result is pitiful not only for business but for the teachers…. The way (these) $3,500 boys accepted $30,000 ($1 then is worth $20 today) a year jobs with the Investment trusts back in 1928 and 1929 and found themselves earnings a pittance as hack writers in 1933 by writing daily columns forecasting the stock prices and estimating the wheat crop”

 

The Delusion of Government

• “The Government should do something about it.

Relief for the farmers is imperative. The Government must guarantee bank deposits. The Government should issue more money. All of these and hundreds more of the same kind were said during a time of deflation. The ridiculousness and inanity of the remarks indicated ignorance beyond belief. There could be no government without people and the economic success of any people depends upon a combination of individual cooperation plus leadership. Therefore, every step taken by the government meant a tax upon the people. Nowhere has this been less understood than in the United States. It was only in March 1933 that a delusion of the government as a separate entity from the people as a whole reached a few of the minds in the mob. The most common aspect of the delusion had to do with money. It seemed the average person believed that all the Government had to do was “make” money. They never seemed to get the idea through their ‘thick skulls’ that the finance of government comes under the same economic imperatives as that of the individual…

If government deludes itself as a separate entity from the individual, the price to be paid for this will be far greater than the pleasure of our belief in it.”

Excerpts from Popular Financial Delusions, by Robert L. Smitley

 

• “The destiny of nations is governed by psychological Influences and economic necessities.”

 

• “…we cannot go back to a currency era without massive upheavals. The cause of the great boom was credit expansion to an abnormal degree-the same cause as that for all booms under a credit system.”

 

• “Possibly the easiest act for any human being is to spend money, which does not belong to him.” The only easier activity is lending money that is not yours and earning a yield on either the profit or loss. Almost anyone will risk funds in an enterprise when the funds are not his own.”

 

• “The great universities find that when their outstanding economic teachers are called into the business arena, the result is pitiful not only for business but for the teachers…. The way (these) $3,500 boys accepted $30,000 ($1 then is worth $20 today) a year jobs with the Investment trusts back in 1928 and 1929 and found themselves earnings a pittance as hack writers in 1933 by writing daily columns forecasting the stock prices and estimating the wheat crop”

 

The Delusion of Government

• “The Government should do something about it.

Relief for the farmers is imperative. The Government must guarantee bank deposits. The Government should issue more money. All of these and hundreds more of the same kind were said during a time of deflation. The ridiculousness and inanity of the remarks indicated ignorance beyond belief. There could be no government without people and the economic success of any people depends upon a combination of individual cooperation plus leadership. Therefore, every step taken by the government meant a tax upon the people. Nowhere has this been less understood than in the United States. It was only in March 1933 that a delusion of the government as a separate entity from the people as a whole reached a few of the minds in the mob. The most common aspect of the delusion had to do with money. It seemed the average person believed that all the Government had to do was “make” money. They never seemed to get the idea through their ‘thick skulls’ that the finance of government comes under the same economic imperatives as that of the individual…

If government deludes itself as a separate entity from the individual, the price to be paid for this will be far greater than the pleasure of our belief in it.”

The Crowd by Gustave Le Bon

Characteristics of crowd psychology: Impulsive-ness, irritability, incapacity to reason, the absence of judgment of the critical spirit and exaggeration of sentiments (crowds do not admit doubts or uncertainty). Crowds are credulous and readily influenced by suggestion. The morality of crowds may be much lower or much higher than that of the individuals composing it.

 

Three processes create a crowd:

Anonymity – Provides rational individuals a feeling of invincibility and loss of personal responsibility. An individual becomes primitive, unreasoning, and emotional which, allows him to yield to instincts.

Contagion – To the spread in the crowd of particular behaviors, where individual sacrifice their personal interest for the collective interest.  Suggestibility – The mechanism through which the contagion is achieved. When the crowd becomes homogeneous and malleable to suggestions from its strongest members-the leaders, the leaders are usually men of action rather than words. They are not gifted with keen foresight and are agitators or hypnotizers of individuals.

 

Impact of civilizing elites and barbarian crowds upon civilization: So far, civilizations have only been created and directed by a small intellectual aristocracy, never by crowds. Crowds are only powerful for destruction. Their rule is always tantamount to a barbarian phase. A civilization involves fixed rules, discipline, a passing from the instinctive to the rational state, forethought for the future, an elevated degree of culture—all conditions that crowds. When the structure of a civilization is rotten, the masses always bring about its downfall.

 

Trading for a Living – Dr. Alexander Elder noted a number of points from Le Bon’s book, Mackay’s book and psychology:

 

• You may base your trades on fundamental and technical analysis but psychology is the key to success.
• Mackay’s book described many of the manias that have occurred in history. Human nature changes slowly and today new mass manias, including guru manias, continue to sweep the markets.

 

INFO FOR BOX VVV

“The public wants gurus, and new gurus will come. As an intelligent trader, you must realize that in the end, no guru is going to make you rich. You have to work on that yourself”                   

END OF BOX INFO

There are three types of gurus in the financial markets today: market cycle (timing the markets) gurus, magic method (new analytic or trading method) gurus and dead (R. N. Elliot or W. D. Gann) gurus.

 

 On mass psychology:

Everybody has a chance to buy and to sell. Each price is a momentary consensus of value of all market participants, expressed in action. Price is a psychological event–a momentary balance of opinion between bulls and bears. Prices are created by masses of traders—buyers and sellers, and undecideds. The patterns of prices and volume reflect the mass psychology of the markets. There is a crowd of traders behind every pattern in the chart book.

 

INFO FOR BOX VVV

Technical analysis is applied social psychology. It aims to recognize trends and changes in crowd behavior in order to make intelligent trading decisions

END OF BOX INFO

 

The market is a huge crowd of people. Each person tries to take money away from the other by outsmarting them. The market is a uniquely harsh environment because everyone is against you and you are against him or her.

 

Today, a trader who reads The Crowd can see his reflection in a century-old mirror. Le Bon wrote,

• When individuals, however like or unlike be their mode of life, occupations, character, or intelligence, have been transformed into a crowd, they are in possession of a collective mind, which makes them feel, think, and act in a manner quite different from that in which each individual would feel, think, and act were he in a state of isolation.

 

• A soldier who trusts his leader will literally follow him to his death. A trader who believes he is following a trend (price is the leader of a market crowd) may hold a losing position until his equity is wiped out.”

 

• Human nature prepares you to give up your independence under stress. When you put in a trade, you feel the desire to imitate others and overlook objective trading signals. This is why you need to develop and follow trading systems and money management rules. They represent your rational individual decisions, made before you enter a trade and become a crowd member.”

 

 

Thoughts from Charles Poor Kindleberger

 

The World in Depression, 1929-1939 was so wide, so deep, and so long because Britain had an inability and America was not willing to assume responsibility for stabilizing the international economic system.

They could have done so by implementing five functions:

1. Maintaining a relatively open market for distress goods
2. providing countercyclical, or at least stable, long term lending
3. Policing a relatively stable system of exchange rates
4. Ensuring the coordination of macroeconomic policies
5. Acting as a lender of last resort by discounting or otherwise providing liquidity in financial crisis

 

The monetary history of the last 400 years has been replete with financial crises. There was a pattern of increased investor optimism as economies expanded. There was an increased rate of credit growth and accelerated economic growth as well as an increasing number of individuals who began to invest for short-term capital gains rather than for the returns associated with the productivity of the assets they were acquiring. The increase in the supply of credit and buoyant economic outlook led to economic booms as investment spending increased in response to a more optimistic outlook and greater availability of credit as household spending increased as personal wealth surged.

 

Economic responsibility and military strength are costs of peacekeeping. Free riders are perhaps more noticeable in the type of economy, in which a number of rules in trade, capital movements, payments and the like have been evolved and accepted as legitimate.

 

Free ridership means that disproportionate costs must be assumed by responsible nations, which must occasionally take care of international interests that fall short of immediate goal. The requirement is for active, not merely passive responsibility of the German-Japanese variety. With free riders and the likely emergency of thrusting newcomers’ passivity is a recipe for disarray.

 

The danger for world stability is the weakness of the dollar, the loss of dedication of the United States to the international system’s interest, and the absence of candidates to fill the vacuum.

Three Types of Bubbles

 Speculative Bubbles:

These are self-fulfilling prophecies. Prices rise rapidly and then fall sharply to a presumed fundamental level. The price keeps rising due to expectations of increased demand. An outside shock comes, breaks expectations and speculative demand evaporates causing prices to fall quickly.

 

No General Panic:

Prices rise, stay at a peak for a while, and then fall as rapidly as they rose. It is not a crash but prices rise above fundamental values and fall again.

 

A Panic and Crash:

Prices rise to a peak and then gradually decline. We then see a panic and crash.

Most investors follow this type of bubble. Some insiders get out at the peak and others hang on during the financial crisis until the panic and crash. Examples of this type of bubble are the Mississippi bubble of 1719, the South Seas bubble of 1720, the U.S. stock market bubbles of 1928-1929 and 1987.

 

Kindleberger, Hyman Minsky and others studied these bubbles.

__________________________________________________________________________________________________                                                      

Based on Kindleberger’s ideas, Hyman Minsky created his credit cycle model. The model had five stages: displacement (investors getting excited about something like an invention war or an abrupt change in economic policy), boom, euphoria (banks and other lenders extend to ever more dubious borrowers, often creating new ways to lend), profit taking (by smart traders and insiders) and panic. It seems history has a script.

 

Kindleberger believed “markets work well on the whole,” but occasionally “will be overwhelmed and need help” from a lender of last resort. He knew the danger of inaction by such a lender and a “moral hazard.” A moral hazard is created when investors are reckless in the belief that they will be bailed out if all goes wrong. He said a lender of last resort should exist, but its presence should be doubted. A lender should always come to the rescue but leave it uncertain as to whether the rescue will arrive in time or at all, to instill caution. Pulling this off is, he noted, a “neat trick”.        The Economist July 17, 2003

 

 END OD ARTICLE

 

 

 

 

    Corporations with common stocks first appeared in the early seventeenth century when monarchs approved them for trade, exploration and colonization purposes. Stocks were first used by speculators but over time, they became accepted as investments. Speculation returned again and stocks fell out of favor by many people.

The East India Company paid dividends of from 95% to 234%. John Perkins Cushing,  a Boston capitalist, had a portfolio of stocks from 1836 to 185 that paid 6.6% from banking stocks, 8.1% from manufacturing stocks, 12.1% from insurance stocks and 8.5% from railroad and canal stocks. As other ventures also paid dividends, investors began to expect dividends.

A diversified portfolio of big dividend paying stocks led by reputable people began to gain acceptance beside bonds and real estate as sources of income. In 1830 when Harvard College sued a trustee, Mr. Amory, the “prudent man theory” was established affirming that a diversified and carefully selected portfolio of common stock could be a wise investment.

Stocks became an investment class but most investors preferred bonds even though stocks paid a higher yield most of the next 100 years. Stocks were perceived to have more risk than bonds or real estate.

In 1912, Irving Fisher, considered one of America’s greatest economists, said common stocks offered some protection against inflation but dividend yields remained high.

In the mid 1960s, a study on portfolios of insurance companies found that over three decades, the weighted average cash dividend yield of common stocks was 5.79% compared with 3.17% cash returns on bonds.

75% of historical returns on common stocks came from cash dividends..

Adding capital gains and dividends together, common stocks showed a return of 7.56%, compared with 3.27% for bonds.

 

Until the 1970s stock yields averaged between 10% and 20% higher than yields on investment grade bonds. By 2000, dividend yields were 80% below bond yields. Dividends were forgotten by most people and capital gains became the preference. By ignoring dividends, most people are leaving around 40% on their total return on the table.

As dividends increase, the stock price often increases creating capital gains opportunities. Both income and capital gains make up total return. People who ignore income are hurting themselves.  

A good total return investment program for many people is one based on income and capital gains similar to the balanced funds that were started in the 1930s.

Good Mutual funds frequently have an annual return of 6% to 10% after ten years regardless their growth or conservative objectives or volatility.

6% to 10% annual return should be an investor’s objective, not trying to beat the market indexes,

John Burr Williams proved the importance of dividends in a portfolio.

A total return portfolio built on dividend growing stocks yielding 120% or more than the 10 year treasury rate could be a good way to build the income stream and wealth needed for future expenses.

Growing income should generate growing capital gains with far less work and stress than what the risk averse world would have you believe.

As for Modern Portfolio Theory

Human emotions, greed and fear, and abusing the rules of compounding with debt should eventually override any academic or math formula justifications for the modern Portfolio theory and will bring dividends and income back into the markets. Income will become more important than risk aversion.

 

 

(Joseph Schumpeter inspired John Burr Williams to write about intrinsic value.)

 

      The central point is that capitalism can only be understood as an evolutionary process of continuous innovation and “creative destruction.”

 

From Schumpter’s Theory of Economic Development: “Excluding any innovations and innovative activities, we have a stationary start. The hero to the stationary state is the entrepreneur who disturbs the equilibrium and is the prime cause of economic development.”

 

     Schumpeter recognized four main cycles: Kondratiev (45-60 yrs), Kuznets (15-25 yrs), Juglar (7-11 yrs) and Kitchin (3-5 yrs).

 

      Added together, the cycles create a composite “waveform” ̶ a Grand Super Cycle of 70 years or more. These cycles occur simultaneously with one rising while the others are declining. If all cycles decline at the same time, the result is disastrous slumps and depressions.                   

1. Focus on Dividends, Not Earnings. 

The intrinsic value of a company is equal to the present value of its future dividends, not earnings. “Earnings are only a means to an end,” Williams argued, “and the means should not be mistaken for the end.”

 

2. Investment versus Speculation. 

     An investor is “a buyer interested in dividends, or coupons and principal,” and a speculator is “a buyer interested in the resale price” alone. Williams thought the volatility of the stock market did not accurately reflect the capacity of companies to pay dividends, and he saw the 1929 stock market crash as “a serious indictment of past practice” of investment analysis. He asserted that if there had been agreement among analysts regarding the “proper criteria of value,” the wild price swings in the crash and its aftermath might have been avoided. With his book, Williams wanted to encourage more true investing and less speculation.

 

3. Lasting Influence. 

Williams undoubtedly influenced the thinking of some of the greatest investment theoreticians and practitioners of the past century.

 

4. On Government, Socialism, and Taxes. 

Williams argued that taxes were a drag on savings, investment, earnings, and ultimately, the value of securities. … government deficits carried with them the threat of higher taxes…Williams  warned that the redistributive nature of excessive taxation, and government control of key industries, would put the US on a path toward socialism.

 

Excerpts from The Theory of Investment Value, by          Cornerstone funds blogs April-May, 12014

 

John Burr Williams’ book, is not about beating the market or getting rich in the market.  It is a wake-up call to the investment elite to offer them a theory of investment value that would encourage more long-term investing and less speculation.  Williams postulated that investors’ inability to properly value stocks increasingly led them to become speculators. Many people would not to being a speculator, but it was clear by their decisions that they were not appraising the intrinsic value of companies but rather betting that they knew something that the market did not.
One of Williams’ most

insightful observations:

 

“To gain by speculation, an investor must be able to foresee price changes.  Since price changes coincide with changes of marginal opinion, he must be able to foresee changes in opinion.  Successful speculation requires no knowledge of intrinsic value. Some seasoned traders think it is a handicap to determine the true worth of speculative stocks. The heart of the problem is how to foretell changes in opinion and dividend.

Financial news broadcasts many opinions but how can one determine what will be news? Investors can cheat or study the market. Since the Security Act of 1934 outlaws cheating, investors can study the forces at work and explore coming events. Williams says it is a rare person who can foresee the future.

Every speculator’s life is strewn with regrets, for the news that he did not understand until it was too late.  “That ‘time and tide wait for no man’ he knows full well; like a bird on the wing must be shot in a jiffy, or she flies out of range forever.”  First speculative opinions are usually wide of the mark, and usually need to be revised.

John Burr Williams was not condemning  speculators, but he was trying to open the eyes of investors to the fact that, as Ben Graham said, “In

the short run, the market is a voting machine (popularity contest), while in the long run it is a weighing machine (measure of value).”

 

Williams’ thesis stated the following: 

 

“The wide changes in stock prices during the last eight years, when prices fell by 80% to 90% from their 1929 peaks only to recover much of their decline later, are a serious indictment of past practices in Investment Analysis [Wall Street]. Had there been any general agreement among analysts themselves concerning the proper criteria of value, such enormous fluctuations should not have occurred, because the long-run prospects for dividends have not, in fact, changed as much as prices have.

Prices have been based too much on current earning power [and] too little on long-run dividend-paying power. Is not one cause of the past volatility of stocks a lack of a sound Theory of Investment Value? Since this volatility of stocks helps….make the business cycle itself more severe, may not advances in Investment Analysis prove a real help in reducing the damage done by the cycle?”

 

How much are US equities over-valued?

By John Schory

 

The downside equity risk

There are articles by financial experts with articles in the *Financial Analysts Journal* that state that a fall of 30% to 50% from current market levels would be required for US equities to be ‘fairly priced’.”

This means that that US equities may be over-valued by $3.3 trillion to $5.5 trillion! A re-adjustment to fair value would be painful, with serious economic and political consequences.

By using John Burr Williams’ formula for equity valuation, investors can check for themselves whether US equities, in general, are fairly priced or not.

As John Burr Williams pointed out 70 years ago, the sensible reason for long-term investors to hold common stocks is to receive a future stream of dividends.

To build up wealth for their retirement, investors should put aside enough current income and reinvest dividends and interest.

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.