The Theory of Investment Value — Williams: COMPLETE

John Burr Williams worked as a securities analyst on Wall Street when, in the early 1930s, he returned to Harvard to pursue a doctorate. He sought a scientific answer to what a stock is actually worth — and discovered that nobody had one. Everything was about price: the course of quotes, charts, rumors, and sentiment. Williams's conclusion was radical in its simplicity: if no one can say what a stock is worth, then the entire market is a bucket shop for guesses, and the crash of 1929 is not proof that stocks are lottery tickets — only proof that prices had departed from value.

To find the value, he looked for something that does not depend on the market's mood: what the company actually pays to its owners.

The result was a doctoral dissertation that Harvard rejected — in hindsight the stated reason was that the work was too mathematical and drew too heavily on other disciplines for the economics faculty's taste. Williams published it instead as a book: The Theory of Investment Value (1938), a work of over 600 pages in which one half deals with bonds and the other builds the theory of valuation from the ground up.

The irony is total — academia said no to the foundation of all modern valuation. A contemporary anecdote further relates that Williams predicted the crash of 1937 and that his boss forbade him from going public with further gloomy forecasts: clients paid for optimism, not for truth. That is the world the book was born in.

Williams's project was as much philosophical as mathematical: to prove that value exists amid the ruins. If a stock's value is the sum of what the company will pay to its owners, then every stock has a value that neither bubbles nor crashes can erase — the price can leave the value behind, never the other way around. The Depression also served as a laboratory: it revealed which companies' cash flows survived and which turned out to be pump stories.

AKM1's variable V12 (revenue stability) is in substance the Depression's lesson formalized — stable revenue is what separates an investment from a wager when the business cycle turns. Williams writes in the preface, in substance, that the book was written in the depths of the Depression to restore to the stock its dignity as an investment, not as a betting ticket.

Williams's core formulation, translated: the value today of any stock, bond, or business is determined by the cash flows in and out — discounted at an appropriate interest rate — that can be expected to occur during the remaining life of the asset. Buffett chose precisely this quotation in the 1992 shareholder letter when he had to explain why Berkshire values companies by present value instead of by trend.

Note three things in the definition: all cash flows (not just next year's), the entire remaining life (not a five-year horizon), and a rate that is appropriate (not just any interest rate). Each of the three later becomes its own chapter in this course.

Williams's deeper point is that an investment purchase is an exchange: you trade present consumption for future cash flows. A bond is the clearest case — you pay today and receive coupons plus redemption on fixed dates. A stock is exactly the same transaction, with a single difference: the coupons are not printed on any paper but are set by the company's board of directors year by year.

That is why Williams says, in substance, that a stock is like a bond with indeterminate coupons — it is not the profit itself that is the value, but the payouts. The analogy makes the toolbox common to bonds and stocks, which explains why half his book deals with bonds: it is the same theory, only with safer coupons.

Follow the logic in miniature. An asset pays 100 kronor in one year and then nothing more. If you require 10 percent, it is worth 100/1,10 ≈ 90,91 kronor today — pay 90 kronor and you earn about 11 percent in return, pay 95 and you get roughly 5,3 percent. The price you pay determines your return, and the value is determined by the cash flow and your requirement — never by what someone else believes the paper is worth next week.

This is the dividing line between investment and speculation in Williams's world, and the foundation of AKM1's separation of price (the valuation multiple V04–V06) and value (the present value of cash flows): the multiple is what the market pays, the present value is what the asset delivers.