Measure twice, cut once. That’s the simple, folksy adage that advises us to double-check first so there are no problems with the final result. Of course, measuring twice assumes you can measure at all. If you can’t measure what you cut, you’re flying blind—to mix metaphors badly.
Those who buy cryptocurrency can’t measure at all. Why? Currencies don’t produce cash—and if there’s no cash yield, there’s no way to measure cash flow to determine intrinsic value, the measuring stick that all investors should carry in their utility belt.
Discounted cash flow analysis (DCF) is the well-established financial reality that all assets that produce cash can be valued because the cash they’re expected to produce can be discounted back to the present (at a rate reflecting the asset’s specific risk). This present value is the intrinsic value of any asset, large or small. Whatever the market price may say, that is the current actual value.
Is it easy to determine intrinsic value? Not at all. Garbage in, garbage out. The inputs must be reasonable, conservative, and accurate. But DCF asks us to make estimates in the future—and predicting the future is always tricky business. The safe solution is to come up with ranges of value, as Morningstar does with stocks, incorporating worst-case and best-case scenarios. As the GOAT investor Warren Buffett says, “I’d rather be approximately right than precisely wrong.”
Take the Kraft Heinz Company (KHC), a stock owned in both my client and personal accounts. KHC trades at $34.15 per share, while Morningstar estimates its intrinsic value to be $50.00. How does Morningstar arrive at this estimate? Through chart reading or a Magic 8 Ball? Not at all; rather, through the tried-and-true method of DCF—the highly educated guess of a company’s fair value derived from its future expected cash flows.
Since Morningstar knows that there’s no such thing as pegging intrinsic value exactly, their enlightened method shows a range of valuations. Essentially, Morningstar thinks that KHC is worth as much as $77.50 or as little as $30.00. It would be highly unusual for a relatively predictable, stable KHC to be worth much more or much less than these range endpoints. So anyone buying at the current price is making a reasonable, educated decision that the company is likely undervalued. To be clear, the value of KHC can be measured.
Bitcoin, at $47,897.38, has no comparable yardstick. Down over 30% from its highs, Bitcoin has lured many a speculator into its orbit. The early investors made fortunes, but those who bought in at over $50,000 are not considering themselves lucky.
Even worse, they have no way to measure once, let alone twice. They cannot assess the intrinsic value of Bitcoin because an asset that produces no cash (whether it be currency or cryptocurrency or gold bullion) gives no clue to its underlying value.
If you invested in Bitcoin at the high of $68,789.63, you have no idea whether to sell now or see what happens. If it goes down further, say below $20,000, as it did earlier this year, you will still have zero idea what to do. Because Bitcoin could be worth $68,000 or it could be worth $0.00. You are flying as blind as it comes. You could rely on Bitcoin pundits and charts to give you a false glimmer of hope that there is some way to make this decision, but there is none—and cold economic reality will tell you that.
So you shouldn’t buy anything you can’t measure, which means avoiding any asset that doesn’t produce cash. That still leaves many good investments, from stocks to bonds to real estate, all of which have that all-important quality: they have a yield that can be measured. Measure the measurable twice, and hopefully you’ll only cut once.
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