The concept of Dow Theory is widely associated with technical analysis. While there's no denying of such a view, investors shouldn't overlook the fact that Charles H. Dow emphasized the concept of value investing in much of his writings. In his Wall Street Journal editorial on February 25, 1902, Dow stated:
"The one sure thing in speculation is that values determine prices in the long run. Manipulation is effective temporarily, but the investor establishes price in the end. The object of all speculation is to foresee coming changes in values. Whoever knows that the value of a stock has run ahead of price and is likely to be sustained can buy that stock with confidence that as its value is recognized by investors, the price will rise (Sether, Laura. Dow Theory Unplugged. 2009. page 81)."
This begs a follow-up question of what is considered of value? In the previous quote, Dow didn't speak of price-to-earnings ratio (P/E) or price-to-book value (P/B). However, one measure of values that Dow mentions often in his writing is dividends. In the book Charles H. Dow and the Dow Theory, by George W. Bishop, Jr., it is noted that Dow makes many references to dividends and its impact on values, as indicated below:
"Determine the stock or stocks to trade in. They should be railroad stocks, dividend payers, not too low, nor too high, fairly active, and for the bull side below their value; for the bear side above their value. Values are determined roughly by earnings available for dividends."
It becomes clear that the oldest tool we can and should use in our investment playbook is based on the actual dividend. Furthermore, not only should a stock provide income in the form of dividend but have a large enough margin of safety to withstand market cycles in case earnings start to decline.
Warren Buffett said the most important concept he learn from Benjamin Graham was a margin of safety. This concept, margin of safety, was made popular in the book The Intelligent Investor which was published in 1949. However, Dow spoke of such concept in a specific manner in many of his editorials. Specifically, his writings indicated that the greatest margin of safety can be had in what we know as the dividend payout ratio. It is one of the aspects our team highlights in our dividend watch list. The quote below is from the Wall Street Journal editorial on January 28, 1902 and might be one of the best examples on the concept:
Nothing strengthens a stock more than margin of safety in dividend earnings, and nothing weakens a stock more than doubt in regard to the stability of dividends. It is unquestionably better for a stock that a company should pay 5% and earn 10% than to pay 9% and earn 10%, because, in the latter case, the small margin of safety must be a great element of weakness in the price (Sether, Laura. Dow Theory Unplugged. 2009. page 352).
All of the examples above provide some of the highlights of Dow's writing. While holding the perception of Dow Theory as a "system" for reading charts, many fail to recognize the inherent discussion of values and fundamentals in the work of Charles H. Dow.