We are living in an era of strong assets and weak traditional currencies. In the last 10 years, Microsoft grew in market cap from $200B to 1,900B. Amazon grew from $80B to $1,600B. Bitcoin went from pretty much $0B to $900B. Even S&P 500 grew 3x.
Gold price change? 35%.
US Inflation over the same period? 19%.
Do we feel that stocks and cryptocurrencies are overvalued? Maybe. Microsoft, a Dow Jones Industrial Index staple, had a P/E of less than 10 back in 2011. It’s 40 now. Cryptocurrencies were “worthless” a decade ago. They are collectively worth over a trillion dollars today.
I’m conflicted about this. What’s a reasonable P/E is anybody’s guess. Tons of research has been done on this topic, but the quickly shifting paradigm has casted doubt over the relevance of this metric. How are startups supposed to be valued? Based on revenue? Sales? TAM? What’s a good multiple? Everyone has an opinion. Opinions don’t really matter.
The truth is, folks, nobody really knows. All the hedge fund managers may lose to a naïve new investor who used his first paycheck to buy Tesla stock 10 years ago because he liked the idea of an electric car. He’d possibly be a millionaire now. You may luck out on one stock and achieve the kind of returns that Warren Buffett has never achieved his entire life. I could be totally wrong about cryptos and end up losing 100% of my investment. Or it could go the complete opposite direction.
As long-term investors, then, how should we go about selecting assets that hold their value or appreciate over time?
I think we need to divorce the asset from its dollar value.
If you’ve taken some econ courses, you know that the dollar, or any modern fiat currency, has a somewhat arbitrary value since it isn’t pegged to a commodity such as gold. Currencies have a long, interesting history along the evolution of the human race. That history landed where we are now, and it is going to continue to evolve. Assigning a dollar value to another type of asset then is arbitrary, and the value is temporary by design. What is less arbitrary is the intrinsic value of the underlying asset.
Many moons ago when I was learning the first things about investing, I learned that when I own a share of a company, I practically own one tiny part of that company. One tiny part of its assets. One tiny part of its future revenue. One tiny part of its future profit. The best way to value the company is thus to estimate how significant this company will be in the future. Let’s take Tesla for an example. Let’s say you were trying to decide whether to invest in Tesla back in 2011 when it was losing money. Did you think Tesla could become a significant company in the future, more than it was at the time? If yes, buy the company’s stock so that you’d own a piece of a significant company in the future. Doesn’t matter what the price was at the time of purchase.
Coming back to the present. Do you think Tesla will be a significant company in the future, more than it is today? If so, buy its stock now and it’ll pay dividend in the future. You won’t know when that future is, but you’ll always own something solid. A company’s valuation fluctuates depending on quarterly financial performance, but regardless of the valuation, it is still the same company.
And your decision should not be driven by the current stock price. Valuation is arbitrary and heavily driven by human emotion which is fickle in nature. It is very difficult, if not outright impossible, to tell with any significant degree of accuracy what the fair value of an asset is. Even the value of the dollar currency isn’t certain – remember it is a fiat currency. I feel that Tesla’s market cap of $800B is way over-inflated, and there are those who feel that Tesla’s market cap could go to $2T. Anyone’s valuation of Tesla is a crap shoot. It’s always been a crap shoot since this company’s inception. I didn’t choose to invest in this company because I didn’t see it dominating the electrical vehicle and energy storage industries as it is today. I am not going to invest in it now because I can’t see it growing its dominance even further. I don’t know Tesla’s P/E. I don’t care if its P/E is high or not. Relying on P/E cost me the missed opportunity of investing in Amazon in 2013. I saw it dominating retail, but thought its P/E was ridiculously high at the time.
The value of an asset should be based on its intrinsic value, not its financial valuation.
Some of the stocks I invest in today are: ADBE, FICO, LUV, and MSFT. Apart from MSFT’s, I don’t know any of these stocks’ P/E. I do follow their stock prices. When they dip and I have money, I buy more. When they pop, I do nothing. Stock prices do not reflect the value of the company – they reflect how people perceive of the company at a point in time. They have their opinions, you have yours, and I have mine. In my own opinion, the underlying companies are going to become more significant in the future. Until there’s a strong reason I should change this opinion, I’m holding.
And Bitcoin? I’m also holding, for the same reason.
Richard Anderson 