Is Bitcoin an investment or mere-speculation?
There is a some serious malpractice going-on regarding the use of the word investment;
Everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin (Ben Graham).
This article attempts to provide the definition of an "Investment" and apply it to Bitcoin and other similar assets such as gold and pension fund schemes.
"Not all purchases of equity shares are investments."
The definition of an investment.
An investment is defined in "The intelligent investor" (Graham,1949) as:
“An operation which, upon
(1) thorough analysis
(2) promises safety of principal and
(3)an adequate return. Operations not meeting these requirements are speculative.”
(1) Thorough analysis entails:
Reading and analyzing annual reports and financial statements in detail,
assessing the honesty and competence of management,
understanding how the company makes money, and
Assessing the future prospects of the company among others
(2) Promises safety of principal.
Value investing is built around the preservation of capital.
Therefore,
investments are only be made when the chances of a loss of capital are low.
The chances of the loss of capital are lowered when more value is acquired than the price paid. Its like paying R1 and receiving R1.40 in value worth.
If you value a company at R300 million that is currently selling for R200 million,
By paying R200 million, you are giving yourself a R100 million gap safety-cushion of incorrectly estimating the value of the company and losing your principal.
Because valuing a company is not a fixed-formula derivative,
there is a high risk of error in estimating the intrinsic value
Different analyst will have different values
You obviously want as high as possible difference between value and price.
This is called a margin of safety
(3) An adequate return.
Return refers to the earnings of the business relative to the cost of the business.
A company with a market capitalization of R500 million making on average annual profits of R40 million gives a return of 8% per annum.
A business opportunity must not be considered in isolation.
10,20 and 30 year South African Government bonds are currently yielding 8.42%,10.19% and 10.27%* respectively in that order
In this situation, the return is not adequate as more returns can be obtained for less risk.
If the company earned average profits of R70million, the return would be 14%.
For an investor
You do not solely look at the price of the asset when assessing its suitability and
You look at the underlying business and what it can produce.
*correct as at 26 Nov. 19
Back to Bitcoin
Buying Bitcoin means that you most likely would have analysed the price charts and macroeconomic factors,
-however, Bitcoin does not offer the promise of safety of principal.
-it is extremely complex to calculate the intrinsic value of Bitcoin.
-the intrinsic value of an asset is derived from what it can produce and not its price.
-Bitcoin does not produce little-bitcoins.
-Contrast this to a fixed deposit earning interest.
-it is therefore a purely speculative tool.
What about gold, private-art, car collections and others?
Same as with purchasing a pension fund a retirement annuity...
The main motivation is to benefit from the price appreciating.
The underlying assets do not produce anything.
Their sole income stream is their price.
Profits can only be made if sold at higher price
Participants hope that the price will continue to go up
Thus, they are speculative in nature.
There is nothing wrong with speculation
However,
We feel the public would be better served if they could differentiate between investing and speculating as the word “investing” is seriously misunderstood.
Japhta Mamalema
26 Nov. 2019