and bond yields was clearly posting a warning signal, but investors still
believe inflation is inevitable and stocks are the only hedge against it.”^3
Yet many on Wall Street were puzzled by the “great yield reversal.”
Nicholas Molodovsky, vice president of White, Weld & Co. and editor of
theFinancial Analysts Journal, observed:Some financial analysts called [the reversal of bond and stock yields] a fi-
nancial revolution brought about by many complex causes. Others, on
the contrary, made no attempt to explain the unexplainable. They showed
readiness to accept it as a manifestation of providence in the financial
universe.^4Imagine the investor who followed this well-regarded indicator
and pulled all his or her money out of the stock market in August 1958
and put it into bonds, vowing never to buy stocks again unless
dividend yields rose above bond yields. Such an investor, if he or she
were still alive, would still be waiting to get back into stocks. After 1958,
stock dividend yields never againexceeded those of bonds. Yet over
the last half century, stock returns overwhelmed the returns on fixed-
income securities.
This episode illustrates that valuation benchmarks are valid only as
long as underlying economic and financial conditions do not change.
The chronic postwar inflation, resulting from a switch to a paper money
standard, changed forever the way investors judged the investment
merits of stocks and bonds. Stocks were claims on real assets whose
prices rose with inflation, while bonds were not. Those investors who
clung to the old ways of valuing equity never participated in the great-
est bull market for stocks in history.VALUATION OF CASH FLOWS FROM STOCKS
The fundamental sources of stock valuation derive from the earnings
and dividends of firms. In contrast to a work of art—which can be
bought both for an investment and for its viewing pleasure—stocks
have value only because of the cash flows that current investors receive
or the appreciation caused by cash flows that future investors hope to re-
ceive. These cash flows may come from the payment of dividends out of
earnings or from cash distributions resulting from the sale of the firm’sCHAPTER 7 Stocks: Sources and Measures of Market Value 97
(^3) “In the Markets,” BusinessWeek, September 13, 1958, p. 91.
(^4) “The Many Aspects of Yields,” Financial Analysts Journal, vol. 18, no. 2 (March–April 1962), pp.
49–62.