Book Review: The Theory of Investment Value

John Burr Williams wrote The Theory of Investment Value as his dissertation. First published in 1938, this book is one of the classics of investing. I will not say that the book is a fun read, for it is not. It is dry and difficult. Half the pages are filled with equations. However, this book was a landmark and it remains relevant. This book is far too large and detailed for me to describe in detail, so I will present but a few of the highlights.

John Burr Williams invented the dividend discount model of stock valuation. Previous economists and stock analysts had only guessed at what the proper P/E valuation was for a company or what the proper dividend yield was. Also, most previous analysts ignored the sustainability of the dividend. In his book, Williams made the point that a company could be valued by calculating the present value of the future dividends (discounting those future dividends at the risk-free interest rate).

However, companies sometimes pay dividends that are unsustainable or that are below their true dividend-paying ability. Williams thus showed how to calculate the sustainable dividend payout. This is also known as owner earnings—it is a measure of the earnings after subtracting necessary reinvestment.

Williams also shows that this can be applied even to companies that do not pay a dividend. He made the point that a company increases in value once it has made money, and thus dividends are not necessary (the stock will increase in value proportional to how much would have been paid out in dividends). (As history has since shown, though, companies that do not pay dividends tend to do worse than those that do, simply because they may reinvest the money unwisely.) Williams thus laid the groundwork for what has later become discounted cash flow (DCF) models of valuation. For some types of companies, dividend discount models are still useful today.

Besides this, the last section of the book is a series of examples, ranging from Phoneix Insurance to GM and US Steel. Even if you only read this section, the book is worth the price. The problems facing investors 70 years ago remain today. We would be wise to learn from the past. By all means buy this book and read it.

Disclosure: This article was originally written two years ago and published elsewhere.

0 thoughts on “Book Review: The Theory of Investment Value

  1. Of course. It is the basis for discounted cash flow analysis. This is still the type of analysis used to value bonds and annuities. For stocks it is not always put into practice because DCF is not robust: a slight change in assumptions leads to very different conclusions.

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