When your coworkers, neighbors, friends, or relatives tell you about how they “made it big” in one investment or another, or when you see news headlines about investments that seemingly go nowhere but up, do you want to join in? Or do you turn a skeptical eye toward your colleague and ask a few simple questions, such as:
Framing any investment idea through questions like these is often a good idea, but especially so when the motive to invest isn’t based on an investment’s fundamentals, but instead simply on the fact it’s going up in price.
We’ve seen speculation throughout much of modern civilization; there was even a bubble in the Netherlands in, of all things, tulip bulbs, in the 1600s. (In case you’re curious, it didn’t end well.) As human beings, we haven’t changed much since then. The Fear of Missing Out, or FOMO, for short, applies to many things in life. Investments are just one aspect. When we see a crowd, we expect there to be a reason why, and humans naturally want to be part of that group, however one may define it.
Right now, two popular investments that draw crowds are cryptocurrencies, such as bitcoin, and marijuana stocks. Let’s ask ourselves those three questions we mentioned above to see how these two investments stack up. But first, we’ll take a short step back in history to put these investments into some perspective.
Yes, the infamous internet bubble. In the nearby graph, where would you feel like you’re missing out? Perhaps you might use your search engine of choice from yesteryear, such as Alta Vista or maybe Hotbot, to find out that Pets.com couldn’t actually make a go of it shipping 40 pound bags of dog food through the mail. Stocks surged, then collapsed, and then the housing bubble took its place in the annals of speculative history and the rather unfortunate ends of two bubbles bursting in just one decade.
I’m sure you get the idea. Bubbles burst, and often the reason why they get inflated so much in the first place is because people rush into them for the simple reason that other people are rushing into them. Now, back to those three questions.
Why is it a good investment, and not just a speculative bet?
Consider bitcoin for this example. You’ll note in the nearby graph that the price remained rather stable from 2013 into 2017 in data from Bloomberg. Then something happened, and its price rocketed higher to reach astronomical heights. Why?
There actually was no fundamental reason why its price suddenly became multiples of what it had been in years past. Is it a good investment? Well, what actually is it?
Bitcoin isn’t a company, so there are no revenues, income, assets or sales. It has no cash flow. It doesn’t make anything. So it can’t be valued like a stock. It doesn’t pay interest, so it can’t be valued like a bond. Commodities have real uses, whether we talk about gold, oil or copper, so it’s not that, either.
That leaves us to evaluate whether it is a currency, determining if it can be a store of value or a means of payment, two primary functions of a currency.
What is it really worth?
As the nearby graph illustrates, it hardly was a store of value when its price plunged from about $19,000 per bitcoin down to its current price of roughly $6,400, give or take, in data from Bloomberg. What changed? Are there any identifiable fundamental forces at work that caused the surge and then the plunge in prices? The answer is “no”.
And as to a currency’s use as a means of payment, I might humbly point out that a check from my checkbook is a means of payment. The paper itself isn’t worth anything, and neither is the wire transfer form from my bank. What is so different about bitcoin from these examples that can justify its price, I might ask rhetorically (but also somewhat seriously)?
How long will a trend last, and is it sustainable?
For this, we’ll turn to the marijuana stocks as an example. We’ll ask a different, yet very basic, question for marijuana stocks: What stops anyone at all from raising and selling marijuana, adding to these firms’ competition? After all, compounds contained in the cannabis plant are not like a pharmaceutical – or even the recipe for a given brand of beer – that enjoys patent protection. In that sense, it’s not all that much different from growing wheat, lettuce or tobacco, or any herbal supplement. You just need production coupled with distribution.
And that is where the big players can step in. Constellation Brands, the alcoholic beverage behemoth, recently purchased a stake in a relatively larger player in the marijuana industry, Canopy, which has much of its operations in Canada. Constellation has an extensive distribution network it can employ – but so do its competitors. And we learned recently that Coca Cola might add a beverage line including a component chemical from the cannabis family, found in both hemp and marijuana plants.
Do small enterprises have a competitive advantage over industry titans like Constellation and Coca-Cola, not to mention other possible contenders such as, say, tobacco companies perhaps? With no barriers to entry, such a price trend of the players currently in the pace right now might seem to lack sustainability if any added competition erodes profits.
There are many reasons to make an investment, not just the fundamentals of the company or vehicle itself, but also your own objectives and risk parameters to consider carefully. Your colleague’s decisions and a fear of missing out on any supposed gains should not be a reason. Remember to ask yourself a few basic questions, such as those we mentioned above, to see if an investment does, indeed, make sense for you.
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