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.