Saturday, September 25, 2010

What constitute an investment?

The way I see it, an investment has to be something that can generate cashflow. Stocks give dividends, bonds give interest and real estate gives rental income. These are real investments.

However in the strange World of Wall Street Craft, anything and everything becomes a feasible investment, an asset class of its own. The recent boom earlier this decade being commodities.

But if you think about it, commodities shouldn't be considered an investment bcos you don't get a cashflow. Holding a ton of copper, or a ton of wheat doesn't give you cashflow. The whole premise is based on prices going up. And when it's based on just prices going up, then it's dangerously close to the idea of the Greater Fool Game. Where you can only make money by selling something that is worth very little, at a higher price, to a greater fool who is willing to buy.

That is why value investors are not interested in price, we are interested in value. Price merely tells us if we can get the asset below its value. If there was no transparent price on the asset, we are happy as long as we have cashflow. But if there is no cashflow, you cannot calculate an intrinsic value of the investment. And in that sense, commodities cannot be classified as an investable asset class. Needless to say, a lot of the newly created asset classes like art, wine, vintage watches and other funny stuff cannot be called investment.

However, if those above mentioned can somehow be construed to generate cashflow, then the story becomes different.

For e.g. if a couple of artworks can be put together at an exhibition hall, and the owner can charge fees for viewers, then we have a cashflow, and the whole business can then be valued. In the same vein, wine is not an investment but the vineyard is. Copper may not be a true investable asset class, but a copper mine or a mining co. is definitely investable.

Similarly, traditional assets that count as investments may not be such if it doesn't generate cashflow. The best examples would be perennial loss making companies. Think Chartered, NOL and the likes.

As the saying goes, cash is king. Well if cash is king, in my opinion, cashflow is then the true master of the universe.