John Burr Williams

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For other people named John Williams, see John Williams (disambiguation).

John Burr Williams (1899 - 1989) was one of the first economists to view stock prices as determined by “intrinsic value” and, in this role, was a founder and developer of fundamental analysis [1]. He is best known for his 1938 text "The Theory of Investment Value", based on his Ph.D. thesis, which was amongst the first to articulate the theory of Discounted Cash Flow (DCF) based valuation, and in particular, dividend based valuation.

1 Biography
2 Theory
3 Publications
4 See also
5 External links and references

[edit] Biography

Williams studied mathematics and chemistry at Harvard University, and enrolled at Harvard Business School in 1923. After graduating, he worked as a security analyst, where he realised that "[h]ow to estimate the fair value was a puzzle indeed... To be a good investment analyst, one needs to be an expert economist also". In 1932 he enrolled at Harvard for a Ph.D. in economics. For his thesis, Joseph Schumpeter suggested that Williams study the question of the intrinsic value of a common stock, for which Williams' personal experience and background would serve him in good stead. He received his doctorate in 1940.

Williams sent The Theory of Investment Value for publication before he had won faculty approval for his doctorate. The work discusses Williams' general theory, as well as providing over 20 specific mathematical models; it also contains a second section devoted to case studies. Various publishers refused the work since it contained algebraic symbols, and Harvard University Press published The Theory of Investment Value in 1938, only after Williams had agreed to pay part of the printing cost. The work has been influential since its publication, and is described as an "insufficiently appreciated classic" [2].

In his last five decades, Williams worked in the management of private investment portfolios and security analysis. He taught economics and investment analysis as a visiting professor at the University of Wisconsin. He also wrote many articles for economic journals [3].

[edit] Theory

Williams was among the first to challenge the "casino" view that economists held of financial markets and asset pricing - where prices are determined largely by expectations and counter-expectations of capital gains [4] (see Keynesian beauty contest). He argued that financial markets are, instead, "markets", properly speaking, and that prices should therefore reflect an asset's intrinsic value [5]. ("Separate and distinct things not to be confused, as every thoughtful investor knows, are real worth and market price...." - opening sentence,Theory of Investment Value.) In so doing, he changed the focus from the time series of the market to the underlying components of asset value. Rather than forecasting stock prices directly, Williams emphasized future corporate earnings and dividends [6].

Developing this idea, Williams proposed that the value of an asset should be calculated using “evaluation by the rule of present worth”. Thus, for a common stock, the intrinsic, long-term worth is the present value of its future net cash flows - in the form of dividend distributions and selling price [7]. Under conditions of certainty, the value of a stock is, therefore, the discounted value of all its future dividends [8] (see Gordon model).

While Williams did not originate the idea of present value [9], he substantiated the concept of discounted cash flow valuation and is generally regarded as having developed the basis for the dividend discount model (DDM) [10]. Through his approach to modelling and forecasting cash flows - which he called “algebraic budgeting” - Williams was also a pioneer of the pro forma modeling of financial statements [11]. In forecasting dividends, williams provides an early discussion of the concept of industry lifecycle (ch. 7).

Today, “evaluation by the rule of present worth”, applied in conjunction with an asset appropriate discount rate — usually derived using the capital asset pricing model of modern portfolio theory (Harry Markowitz and William Sharpe), or the arbitrage pricing theory (Stephen Ross) — is probably the most widely used stock valuation method amongst institutional investors [12]; see List of valuation topics.

Williams also anticipated the Modigliani-Miller theorem [13]. In presenting the "Law of the Conservation of Investment Value" (Theory, pg. 72), he argued that since the value of an enterprise is the "present worth" of all its future distributions - whether interest or dividends - it "in no wise depends on what the company’s capitalization is". Modigliani and Miller show that Williams, however, had not actually proved this law, as he had not made it clear how an arbitrage opportunity would arise if his Law were to fail.

[edit] Publications

The Theory of Investment Value. Harvard University Press 1938; 1997 reprint, Fraser Publishing. ISBN 0-87034-126-X
International trade under flexible exchange rates. 1954
Interest, Growth & Inflation 1964; 1998 reprint, Fraser Publishing. ISBN 0-87034-131-6