SHOW ME THE MONEY
An asset that captivates the crowd is good, but an asset that pays you a regular sum of money is even better.
Why? Because it lessens the need to find a buyer willing to purchase at your desired price when you decide to sell. Furthermore, if you acquire an asset that yields a fraction of the purchase price over a long enough period, you will eventually reach a breakeven point. Consider, for example, renting out an apartment or lending money to a friend, where the monthly payments you receive accumulate until they cover your initial investment.
The presence of regular cash flows is a prerequisite for many investors because they offer visibility, tangibility, and a foundation for determining the future value of the asset.
Some aficionados even believe that you should systematically pass on any investment opportunity that doesn’t generate cash flows. The debates within the financial community are intense, with some arguing that assets like cryptocurrencies and gold, which lack utility and income streams, hold no value. I’ve always found these debates to be futile, for a simple reason: In theory, you can derive an income stream from almost any asset.
Gold itself doesn’t produce cash flows, but a company that extracts gold and sells it does. A piece of art is essentially pigments on a canvas, yet museums are often profitable organizations. Cryptocurrencies don’t distribute dividends, but you can stake them, and so on. Cash flows are just interest converted into cash.
So, it is better to frame the question differently: Can the asset be a generator of value?
The primary condition for qualifying as a generator of value is the potential for direct or indirect monetization. Is it possible to transform the interest in the asset into a stream of income in one way or another?
For instance, companies sell products, and by investing in their stocks, you might anticipate that you will receive a portion of their revenue in the form of dividends or buybacks eventually. Lending your private art collection to a museum could save you carrying costs, enhance its visibility, and ultimately increase the value of your collection.
Assessing the current value creation is crucial, but even more critical is the asset’s ability to continue generating value in the future.
The asset’s future value generation potential hinges on two additional conditions:
- Scalability: If the cash flows from the asset can scale over time, this will significantly enhance its value. We often focus too much on assets that are scarce, forgetting that value can also derive from network effects. High-adoption technologies or companies with extensive user bases exemplify scalable assets.
- Embedded Protection: Popular assets are likely to attract competitors or malefactors. Good ideas and innovations are quickly commoditized, and it is only natural to see cash flows decrease over time. It’s essential to choose assets capable of protecting their value as time passes, such as companies with a competitive edge or monopolistic position capable of preserving their margins, or collectibles resistant to counterfeit.
To summarize, another criterion for distinguishing promising investment opportunities from duds is the “generator of value” test, encapsulated by three key principles: Monetize, Scale, and Protect. Favor assets that can generate growing income over time. If you find an asset that passes both the store of interest and generator of value tests, you can be reasonably confident that you are in the presence of a solid investment opportunity.
And now, it’s time to turn to a third test: the “What Could Go Wrong?” test.