ABSTRACT
§ 5-1. In 1937, John Burr Williams, one of the founding fathers of what today is known as the fundamental analysis approach to equity valuation, argued that an asset’s value should be determined by calculating the present value of its future cash flows. ‘A cow’, wrote Williams, ‘for her milk. A hen for her eggs, and a stock, by heck, for her dividends. An orchard for fruit, bees for their honey, and stocks, besides, for their dividends.’ Thus, said Williams, since future dividends are the cash flows one expects to receive from an investment in ordinary shares, it necessarily follows that one should determine the intrinsic, long-term worth of an ordinary share by calculating the present value of the dividends that one expects to receive from it. Nowadays, this approach for determining intrinsic value is widely used in the financial markets, although it is normally applied in conjunction with an asset pricing model, such as the Capital Asset Pricing Model (CAPM), in order to provide a rational basis for determining the cost of equity to be used in the discounting process.
