144 ShowMetheMoney
Graham sai dthe margin of safety principle ultimately serve das
the touchstone in distinguishing between investing and speculation.
Those who deny the difference between price and value or fail to
get a margin of safety take their seats at the roulette wheel. Place
your bets!
CASH
The same judgment can be applied to the cash a company is ex-
pecte dto generate an dpay to sharehol ders in the future. The cash
dividend–based approach to valuation was championed by John Burr
Williams, who argue das follows:
Earnings are only a means to an end, and the means should not
be mistaken for the end. Therefore we must say that a stock
derives its value from its dividends, not its earnings. In short, a
stock is worth onlywhat you can get out of it.
In saying that dividends, not earnings, determine value, we
seem to be reversing the usual rule that is drilled into every
beginner’s hea dwhen he [or she] starts to tra de in the market;
namely, that earnings, not dividends, make prices. The apparent
contradiction is easily explained, however, for we are discussing
permanent investment, not speculative trading, and dividends
for years to come, not income for the moment only.
Of course it is true that low earnings together with a high
dividend for the time being should be looked at askance, but
likewise it is true that these low earnings mean low dividendsin
the long run. On analysis, therefore, it will be seen that no con-
tradiction really exists between our formula using dividends and
the common precept regarding earnings.^12Williams indicates that dividend discounting and earnings capi-
talization give the same answer (or range of answers) to the question
of what a share of stock is worth.
This is the case because dividends are a subset of earnings. A
corporation can deploy its earnings either by paying them out to
shareholders as dividends or retaining them for reinvestment in the
business. If the retaine dearnings generate a return equal to the cap
rate, the value you get from capitalizing the earnings stream will be
the same as the value you get from discounting the dividend stream.
Indeed, valuation by discounting dividends is analytically iden-