Buffett, Bitcoin, and a Lesson From 1900

90 seconds is plenty of time to tell the story of a stock. If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.

– Peter Lynch

Buffett Wisdom

There’s a great website called The Buffett. Check it out sometime.

It’s filled with quotes from Warren Buffett filtered by subject matter. It has a lot of quotes from Charlie Munger too.

You could spend days reading everything. Anyhow, I came across a few topics that are worth sharing.

They are at the foundation of what it takes to be a successful investor. We covered a lot of ground on price and value the past week or two.

So, who better to learn more about value from than Warren Buffett?

Today and tomorrow, I’m going to share with you some of his insights (in question format courtesy of The Buffett).

Today’s Buffett wisdom is about value and how to build your investment knowledge…

What do you believe to be the most important tools in determining intrinsic value? What rules or standards do you apply when using these tools?

Warren Buffett:

If we could see in looking at any business what its future cash flows would be for the next 100 years, and discount that back at an appropriate interest rate, that would give us a number for intrinsic value. It would be like looking at a bond that had a bunch of coupons on it that was due in a hundred years…

Businesses have coupons too; the only problem is that they’re not printed on the instrument and it’s up to the investor to try to estimate what those coupons are going to be over time. In high-tech businesses, or something like that, we don’t have the faintest idea what the coupons are going to be.

In the businesses where we think we can understand them reasonably well, we are trying to print the coupons out. If you attempt to assess intrinsic value, it all relates to cash flow. The only reason to put cash into any kind of investment now is that you expect to take cash out – not by selling it to somebody else, that’s just a game of who beats who – but by the asset itself…

If you’re an investor, you’re looking on what the asset is going to do, if you’re a speculator, you’re commonly focusing on what the price of the object is going to do, and that’s not our game.

We feel that if we’re right about the business, we’re going to make a lot of money, and if we’re wrong about the business, we don’t have any hopes of making money.

Charlie Munger:

The first question we ask ourselves is, would we rather own this business than more Coca-Cola, than more Gillette…

We will want companies where the certainty gets close to that, or we would figure we’d be better off buying more Coke. If every management, before they bought a business, said is this better than buying in our own stock or even buying Coca-Cola stock, there’d be a lot less deals done. We try to measure against what we regard as close to perfection as we can get.

Source: BRK Annual Meeting 1997, www.thebuffett.com

How do you build your investment knowledge?

Warren Buffett:

We read a lot: daily publications, annual reports, 10Ks, 10Qs, business magazines, etc.

Fortunately, the investment business is one where knowledge accumulates and builds into a knowledge base that’s useful. There’s a lot to absorb over time. 40-50 years ago, I visited a lot of companies, but haven’t done this in a long, long time.

Charlie Munger:

The more basic knowledge you have, the less new knowledge you have to get. The guy who plays chess blindfolded [a chess master comes to Omaha during Berkshire’s annual meeting weekend and, in an exhibition, plays multiple players blindfolded] – he has a knowledge of the board, which allows him to do this.

I’d hate to give up The Wall Street Journal.

Warren Buffett:

You want to read a lot of financial publications. The New York Times has a much better business section than it had 25 years ago. Read Fortune.

I don’t read any analyst reports. If I read one, it’s because the funny pages weren’t available. I don’t know why anyone does it.

Source: BRK Annual Meeting 2003 Tilson Notes, www.thebuffett.com

Should Bitcoin Be Priced as a Commodity?

There was an article on Bitcoin in the Wall St. Journal on Friday. The idea is to price Bitcoin like a commodity.

From the WSJ:

Is a bitcoin worth the $15,000 it commands today, or is it really worth about $3,000? The huge run-up in value since September suggests the lower figure…

If bitcoin is an investment, it most closely resembles gold. Both are stores of value that provide some built-in protection against inflation because there is a finite supply and because extracting new deposits gets more expensive over time, barring big technology changes.

The most important factor in gold prices over the long run is production costs, which acts something like a natural price floor when demand dips. Of course, gold prices can also temporarily move much higher when demand is strong but tend to fall back toward the marginal cost of production once worries about inflation or the dollar subside and gold begins to lose its appeal as a hedge.

The last great bull market in gold is a classic example: Prices peaked at around $1,900 a troy ounce in 2011 – more than three times the production cost, at the time for Barrick Gold, the largest listed gold producer. By the end of 2016, gold prices had plummeted to $1,151 a troy ounce, above Barrick’s production cost of $844, according to FactSet.

Applying the same analysis to bitcoin suggests its price could face a steep fall if demand dries up. The cost of minting a bitcoin is as low as $3,224 in Louisiana, according to an analysis by the Crescent Electric Supply, one of the largest electrical suppliers in the U.S…

Electricity is the biggest cost for bitcoin miners once they fork out for their equipment.

If investors start to value Bitcoin like a commodity, then we could see a big fall in price.

The other side of the story is that many investors value it in terms of transactional demand for buying goods and services. In this case, the value of Bitcoin would be based on monetary value… Something like the U.S. dollar, Yen, Euro etc.

I talked about this back in November. You can catch up here.

I’ll leave you with a quote from the Editorial section of the WSJ in 1900, titled Review and Outlook.

It applies just as much today as it did back then…

A Note on Price and Value from the Wall St. Journal – January 8, 1900

At present, it may be taken for granted that every operator who is trying to forecast the market is considering whether the 1899 boom in business is going to last…

The market is full of cross currents and the prices of individual stocks always come to a proper relation to their value in the long run, but good stocks and poor ones move up and down in sympathy, as the general market rises and falls.

The practical hearing of this is that an operator who reaches a conclusion that the market generally will be lower three months hence should sell the stocks which are intrinsically to dear, while if he thinks the market will be generally higher in the Spring as a result of conditions as he sees them, he should buy the stocks which he thinks are intrinsically too cheap.