Last Updated on April 26, 2022 by Rational thinking
Bitcoin has appreciated a lot over the last years, and polarized discussions on social media continue endlessly about which asset will perform the best in the future. Many swear to bitcoin and cryptos, while others swear to the more traditional assets like stocks, real estate, and gold. This article looks at productive vs unproductive assets.
The problem with gold and bitcoin is that they don’t create any tangibles values – they don’t throw off cash. Thus, we believe they are unlikely to beat stocks over the long run (decades). In this article, we explain why.
We own all asset classes (assuming cryptos are an asset class), but we own substantially more stocks than we own of the other asset classes. The reason is simple: we like to own pieces of businesses that produce positive cash flows year in and year out. We want to own real productive assets that make us financially secure no matter what currency is in use.
Most investors are either 100% against or 100% for bitcoin. We are neither. However, we regard bitcoins and other cryptocurrencies mostly as a call option for the future of finance. Please bear in mind that we are a bit old school and our take reflects that (that’s the disadvantage of being older than 50….).
An option is like insurance, and most of the insurance premiums end up lost. That’s the nature of insurance. However, we believe that bitcoin and cryptos are here to stay, but in what form and at what value is basically impossible to say. Because of the uncertainty, we have just a very small allocation to cryptos.
The internet changed the world in a big way, but most of the internet stocks ended belly up. When something new, innovative, and disruptive enters the arena, it’s hard to predict the outcome. We suspect the crypto market is no different.
Will bitcoin be the new gold? Who knows. Will bitcoin be widely used for buying and selling goods and services? We believe this is highly unlikely. Is it here to stay? Yes.
Are bitcoin and crypto better than stocks?
In order to answer this, we need to understand what the two different asset classes are. We are by no means any experts on cryptos, but we believe we understand enough to be reasonably qualified to have an understanding of what the main differences are.
What is a bitcoin?
Bitcoin is a decentralized digital currency or token that saw the day of light right after the GFC in 2008/09. Still today, it’s a mystery who is the “inventor” and author of the current and its whitepaper. Who is Satoshi Nakamoto? A person? An institution? An organization? Who knows, and the longer it goes, we assume the less likely is it to know who is the creator.
It’s not a physical asset but is a number of electronic digits. Transactions and balances are kept on a ledger that is public for everyone to see, albeit you only see numbers, you don’t see “trader Joe” owning a certain bitcoin. When you sell a bitcoin to someone in Nigeria, it gets recorded on the ledger for everyone to see. However, the real owner might be difficult to reveal.
One of the main advantages of bitcoin is that it’s decentralized and the supply is limited. Unlike central banks, you can’t just “print” more bitcoins than already programmed to. Because of this, many believe bitcoin is a hedge against coming inflation and a store of value.
What are shares (or stocks)?
Productive vs. unproductive assets:
We can say stocks are productive assets, while bitcoin and cryptos are unproductive assets.
Bitcoin is an unproductive asset – bitcoin produces no income
For unproductive assets, there is only one way to profit: by having someone else pay more than you paid for it. This can, of course, be achieved by increasing the network effect and scalability of bitcoin. The more who use bitcoin, the more valuable it can get. The more institutions that accept bitcoin, the better the networking effect.
But its weakness is that it doesn’t throw off cash.
Does this mean that Bitcoin and crypto are a Ponzi scheme? Of course not, although Nassim Taleb recently said it resembles a Ponzi scheme. Gold doesn’t produce any tangible values either but has still managed to maintain its purchasing power over thousands of years.
However, if you own one bitcoin today, you still only own one bitcoin in 2030. Likewise, as Warren Buffett says, if you own one ounce of gold you will still only own one ounce of gold in 2030.
Stocks are productive assets – stocks produce earnings and cash flows
Productive assets have a huge advantage over unproductive assets: it throws off cash. As long as society doesn’t crumble and go under, productivity gains will make owning productive assets more valuable as time goes by.
Why is that?
Because over the long run, most of the profits from owning stocks come from the retained and reinvested earnings or reinvested dividends. Howard Marks calls this the interest on the interest (to use a phrase from the bond market).
It’s not the initial investment that potentially makes you rich, but the reinvested earnings and dividends. Thus, the marginal rate of return is extremely important.
It snowballs – it compounds. This is exactly what has made Warren Buffett so rich. He’s probably a fantastic investor, but his wealth comes from his ability to delay gratification by reinvesting all the profits to let it snowball.
- Dividend investing: the marginal rate of return
- Compounding – the magic of a long-term mindset and delayed gratification
Let’s illustrate why Warren Buffett has made 99% of his assets after he turned 50:
An investment that grows like clockwork at 10% annually, has multiplied 6.7 times after 20 years. But if you wait ten more years, ie 30 years, it is worth 17 times more. The last ten years are only one-third of the time period, but it lets you accumulate 60% of the gains. This is exponential growth!
If you manage slightly better returns, let’s say 11%, the numbers are 8 and 22.
Again, you can’t compound an unproductive asset like bitcoin or gold. Thus, in the long run, stocks should be a better investment.
If you are interested in compounders, we give you a humble reminder that we offer a model portfolio called the “Berkshire Clone/Componder” portfolio.
Why a productive asset is more valuable than an unproductive one – in the long run:
The math is simple: if you invest 100 and manage to grow 30% annually and reinvest at the same rate, you have 130 after year one. After year two you have 169, not 160. After year three you have 220, not 190. Your assets grow exponentially! (We used a high rate of return to better show the exponential growth). The longer you wait, the better the rewards.
Exponential growth is best illustrated in a graph to show how reinvested earnings grow at different rates of return:
The higher incremental returns, the steeper the curve.
Let’s say you own ABC Food, a company that wants to acquire food companies and manage them “hands off”. The company is small and has no plans of paying any dividends for the foreseeable future, but prefers to reinvest all earnings back into the existing business.
Let’s say you own 0.1% of this food business and indirectly own part of let’s say 20 businesses/subsidiaries. If the company manages to buy back 20% of the shares and reinvest into ten more businesses over the next 15 years, you own 0.12% of 30 businesses after 15 years. Again, the snowball effect helps you compound.
You can’t snowball bitcoin or gold. That’s their inherent problem. This is why gold has underperformed stocks massively over the long run, something we wrote about earlier about how to protect against inflation:
Warren Buffet and Charlie Munger’s take on bitcoin
Warren Buffett is ridiculed for not “understanding” cryptos, but he is disciplined and stays within his circle of competence. For those of us who remember the dot-com bubble, he was also ridiculed for not investing in internet stocks.
Actually, to our knowledge, he has not to this day made any significant investments in technology (however, perhaps his investments in IBM and Apple could be called tech stocks).
One of the reasons is the lack of predictability and estimations of intrinsic value. How can you invest if you have no idea what the value will be in x number of years? Most tech stocks end up at the bottom of the performance rankings, while just a few make it to the top:
Munger and Buffett never invested in gold because it doesn’t produce any income. It’s a “dead” asset. For the same reasons, they don’t invest in bitcoins and cryptos. They can’t compound.
Is Bitcoin a hedge against the financial system?
During the GFC in 2008/09 most asset classes “broke down”. The system was on the brink of collapse, and we believe it’s in a worse state now than then. As such, bitcoin could be a hedge against all this because it’s decentralized and unleveraged.
Is bitcoin a hedge against inflation?
For those who are under the age of 50 and grew up in the Western world, inflation has never been a real issue to deal with. But this might come to an end. Central bank’s balance sheets have expanded, and trillions of dollars have been created “out of thin air”.
However, we fail to see that bitcoin is a play on inflation. The price action indicates that this is mostly speculation – not hedging. Many advocate bitcoin as an investment, but in reality, mostly it’s used for speculation. Interestingly, people speculate in bitcoin to make money in dollars – which happen to be a useable currency, despite an increasing supply.
Basically, there’s no connection between inflation and Bitcoin. None. I mean, you can have hyperinflation and Bitcoin going to zero. There’s no link between them.
The above is what Nassim Nicholas Taleb said in an interview on CNBC in April 2021, just days after Taleb sold all or most of his bitcoins.
We would say the jury is still out on the inflation issue. Let’s just say that bitcoin has a lot to prove as a hedge against inflation.
Bitcoin is too volatile and risky
Bitcoin is very volatile. Why is it volatile? Most likely because it’s difficult to value. Furthermore, it’s subject to rampant speculation. Because of this, we certainly can’t say it’s a “store of value”.
But volatility is not the main problem. It is a symptom of the problem, which is no connection to any useful businesses or services (at least as of now).
Tesla invested in bitcoin and made it legal tender if you wanted to buy a car, but in a “surprise” move decided to return to dollars. The result was a 30% drop in the value of bitcoin.
In The Intelligent Investor Benjamin Graham writes that investing is about analyzing the safety of your investment/principal and the likelihood of getting a “satisfactory” return. Because Bitcoin is such a new innovation, we fail to see how bitcoin can fit into such a description.
If you are worried about sudden inflation, why not go for gold or real estate? They have data going back centuries and have proven to hedge well against “sudden” inflation. These two asset classes at least have something bitcoin and cryptos don’t: they are physical. If all of them goes to zero (in value), you at least have something useful if you own real estate or gold: You can build/grow/live on your property, or you can put gold necklaces around your neck.
Likewise, if you own maturing whisky, yet another physical asset that serves a purpose, you can at least take delivery and drown your sorrows if your casks become worthless:
We let Taleb end the paragraph about inflation:
If you want to hedge against inflation, buy a piece of land. Grow, I don’t know, olives, on it. You’ll have olive oil. If the price collapses, you’ll have something.
Is bitcoin a scarce commodity?
One of the main arguments for bitcoin is the limited supply. But does scarcity necessarily mean it’s a good investment? We appreciate that argument and it might be a valid one.
However, there exist over 1 000 different cryptos, to our knowledge, and it’s of course no limits on how many you can “invent” and offer for supply. The total valuation is already over one trillion USD combined. What crypto will be the winner in the future? Who knows.
Technology is always changing fast. When the internet started getting useful in the 90s, the market was flooded with internet companies. Sadly, most of them went belly up and no longer exits.
Likewise, even if the blockchain becomes useful for everyday use, it’s hard to predict the outcome of cryptos and their value.
Conclusion: In the long run, stocks should be a better investment than bitcoin
Now that we have explained productive vs unproductive assets, we conclude that, in the long run, stocks are a better investment than cryptos and Bitcoin. The reason is simple: You own productive assets that can compound and grow.