Wednesday, April 02, 2014

ABCs of Dividend Investing: John Burr Williams, The Father of Dividend Investing Still Speaks

Because we have long espoused John Burr Williams' theories of dividend investing, we are often asked why he focused on dividends and not on earnings in determining a stock's value.  This prioritizing of dividends ahead of earnings was controversial in 1937 when he published his book, The Theory of Investment Value, and it remains so today.

This is Part I of a series of three blogs in which we will describe who John Burr Williams was, why he believed dividends trumped earnings in determining the intrinsic value of a company, and finally, why his theories on economic growth matter so much today.

In 1937 near the end of the worst bear market in US history, Williams, a thirty-five year old Harvard doctoral student in economics, made the following statement in his thesis: 
“The investment value of a stock is the present worth of all future dividends to be paid upon it . . . discounted at the pure [risk less] interest rate demanded by the investor.”
Mr. Williams’ dissertation did not immediately earn him his doctorate.  That would not be forthcoming until 1940.  Prior to his final oral exam, he sold the rights to his thesis to Harvard University Press, who published his dissertation as a book, but only with Mr. Williams subsidizing a portion of the costs. 

It would seem that only a fool would sell his doctoral thesis before he had been granted the degree. Williams, however, who was already a successful Wall Street investor when he went back to Harvard, explained that he had returned to college to learn what had caused the 1930s stock market crash (and the subsequent economic depression) from the best minds possible.  Since he had come for the knowledge and not the degree, and since his work was complete, he wanted to share his findings with the public as quickly as possible. 

What he did not say at the time, but would later admit, was that because of some of the views he had expressed in his thesis, he had become persona non-grata with key Harvard professors and was unlikely to have been awarded the degree anyway. 

Blaming the Bureaucrats 

His troubles with the dons of the school of economics were many but were centered in two areas: (1) Williams claimed that the correct method for determining the intrinsic value of a company was by calculating the present value of its future dividend payments, not earnings as was the universal belief at the time, and (2) he voiced great skepticism of the theories of John Maynard Keynes and the New Deal programs of President Franklin Roosevelt.  Williams devoted an entire chapter in the book entitled "Taxes and Socialism" to debunking the notion that the redistribution of wealth could lead a country to prosperity.

Finally, in 1940, with the book drawing praise from important financial commentators, and his success as an investor gaining accolades, John Burr Williams went before the Harvard dons to seek his doctorate. 

As expected, he was soundly criticized for publishing the thesis before he had obtained his doctorate, and his professors were upset that he did not embrace Keynes’ teachings. Oddly enough, however, they did not dispute his dividend-centric theory of investment value but questioned if a thesis studying the valuation of stocks had enough significance to justify a doctorate in economics from Harvard.  After a heated debate, he was granted his doctorate. 

The truth is often born of travail, matures under constant testing, and once acknowledged, is subject to twisting.  That has certainly been the case with John Burr Williams’ theory.  What had angered his Harvard professors, at first, caused Wall Street brokers to scoff.  The majority of the wizards of Wall Street believed then, as they still do today, that earnings are the driver of stock prices and that dividends are only a by-product.  Furthermore, intrinsic value has never commanded a big following on Wall Street, where trading and short-term speculation have long been the accepted modus operandi

Blaming Wall Street 

A closer reading of the book, however, turned Wall Street’s ridicule to scorn.  The ways of Wall Street were being blamed, at least partly, for the stock market crash.  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, 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 in turn to 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?” 

Gradually, particularly among seasoned investment analysts and some academicians, Williams’ valuation theories gained credence. Arnold Bernhard, the founder of “The Value-Line Investment Survey,” perhaps the most famous of all independent, investment research firms, quoted Williams in his book, The Evaluation of Common Stocks, and echoed his concerns, 
“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." 

Myron Gordon in his 1959 book, Dividends, Earnings, and Stocks Prices, 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' ground breaking work.  There are many academics, as well as, investment professionals who believe that Mr. Williams' work also deserved a Nobel prize.

John Burr Williams is called the "father of dividend investing," but he was much more than that.  Williams recognized that the erratic behavior of stock prices was caused by a lack of connection to the true, fundamental value.  He was one of the first people to quantify the intrinsic value of a company.    

John Burr Williams' theories are the foundation upon which we have built our Rising Dividend Investing strategy.  Over the last 20 years of employing his ideas, we have seen time and again that prices for individual stocks and the market as a whole are often disconnected from what is later shown to be their true intrinsic value.  

Next time, we will discuss Williams' views on investing versus speculating.  

Monday, March 24, 2014

Hot News Comes and Goes, But Dividends Are Forever . . .

Investors are constantly inundated with the latest regional conflict, political debate, economic data and interest rate predictions. All of this information represents the collective viewpoint or “consensus” of investors at any given point in time.

Over the many years we have spent studying the markets, the truest thing we know is that the consensus is already priced into the market... and the consensus is almost always wrong. If an investor believes the economy and earnings will be better in the future, they will “vote” with their money. In aggregate, all of those votes create the price level for a particular stock. If the consensus comes true, you won’t see much of a change in the markets and prices will generally drift sideways.

What changes the price of stocks are the things that the consensus doesn’t already expect. Therefore, the only way to make excess risk-adjusted returns is either:

1) Find where the consensus is wrong.
2) Look outside the box.

Thursday, February 27, 2014

How Dividend Payout Ratios Impact Valuation

   One of the greatest misconceptions among investors is that valuing the market at any given time is impossible. Many people seem to believe the stock market is nothing more than a betting parlour where today's price or tomorrow's price is whatever the fickled gods of Wall Street decree it to be.

Part of this misconception comes from the many voices in the media that are at the extremes in their predictions of where the market is going. On one side, the “stock market bubble” pessimists (who have been saying the same things for the past 5 years) are predicting that the market is overvalued 25% or more. On the other hand, many in the bullish crowd are saying the market is as much as 25% undervalued.

Whom are investors to believe?

Thursday, February 13, 2014

Consolidating, Validating and Recalibrating

A number of different worries have rattled the market to start 2014.  Let’s take a closer look at what they are and what each of them means for the global economy and markets.

1. Housing Slowdown

Housing represents a very large part of the U.S. economy (about 20%), which is why economists and investors alike pay close attention to housing data.
After a strong 2013, the housing market data has weakened.  New home construction surged in November 2013, but fell in December 2013 and January 2014.  Rising interest rates are likely to blame.  Mortgage rates have risen to 4.5% from their lows around 3.5% in early 2013.  The threat of rising interest rates in 2014 and 2015 has investors concerned that the weakness in housing may continue.

The lull we are seeing in the data could be a result of last year’s low rates, which likely pulled forward some purchases that may not have ordinarily occurred until six months to a full year later.  The abnormally cold winter may also be

Tuesday, February 11, 2014

ABCs of Dividend Investing: How to Navigate the Current Sell-off

Since the beginning of the year, stocks have fallen by about 5%.  The modest pullback has many investors wondering whether a full out “correction” (drop in prices by 10% or more) is on its way.  

When the inevitable fluctuations in stock prices come, investors are all left with the same question: What should I do with my portfolio?

At Donaldson Capital Management, we have a particular strategy for handling market upswings and downswings.

What Is An ABC Portfolio?

As many of you are familiar, we invest only in dividend-paying stocks but we break down our portfolios into three types of dividend-paying stocks.  For those of you who are not familiar, we structure our portfolio into A, B and C stocks.  

Below is a summary of each sub-portfolio and it’s specific characteristics.  You can read about each sub-portfolio in more detail here.

Our primary investment model (“Rising Dividend-Cornerstone”) is comprised of all three types of dividend stocks.  

Regardless of what type of market we are in, a portfolio of A, B and C dividend stocks will have at least one group that performs better-than-expected.  This type of portfolio significantly outperforms

Tuesday, January 28, 2014

Dividends: A Guiding Compass in Choppy Stock Market Waters

At the close of the market on January 27th, the S&P 500 was down 3.1% from its record high on January 15th.  This modest pullback has caused nervousness amongst many investors.

Is this pullback something long-term investors should be concerned about?  We don't think so.  Here's why:

1. Stock Market Volatility is Normal

The market's unbroken march upward in 2013 caused many investors to forget what market turbulence looks like.

With so many forces at work in the stock market, it is difficult for one particular trend to last for a sustained period of time.  The market is positive 7 out of 10 years, but the standard deviation of 20% around the long-term average of 10% would make anything between 0% and 30% normal.  Rarely does the market advance higher without

Friday, January 17, 2014

The ABCs of Dividend Investing: Divi-do or Divi-don't?

Low interest rates have propelled dividend income investing to greater popularity in recent years than at any time in the past six decades.

Despite dividend-investing's recent popularity, many investors still only look at one facet of the power of dividend investing: dividend yield.  These investors point to the fact that dividends have represented 40% of the total return of stocks since 1960 and that many dividend stocks yield more than short-term Treasury bonds.  But that is where they stop, and in doing so, they miss an important quality of dividend investing: dividends are more than income, much more. 

The most important element of dividend investing is the statistically significant long-term relationship between dividend growth and price growth.  Understanding this relationship is the key to unlocking the true power of dividend investing.