by Jim Pearce, Investing Daily
Investing Daily Article of the Week
Should you buy stock in a company because it owns a lot of Bitcoin (BTC)? That question may have seemed absurd a year ago when the cryptocurrency hadn’t gained any ground over the previous three years. But now that Bitcoin is surging in value, more companies are turning to it as an alternative to fiat currencies.
Since the onset of the coronavirus pandemic, the federal government has spent trillions of dollars in relief money and fiscal stimulus. That has serious implications for the future value of the U.S. dollar. It also may explain why the price of Bitcoin has surged more than 10 times in value since last March.
For the purposes of this discussion, let’s assume that there is no risk of theft or forgery of cryptocurrencies to consider. Although that is not the case, attempting to quantify those technological risks is far beyond my computational skills.
Let’s also assume that none of the major industrialized nations outlaw cryptocurrencies or limit their convertibility into fiat currencies such as the U.S. dollar and Chinese yuan. That may also not turn out to be the case, but at present that is an unquantifiable risk.
From an investment perspective, the primary concern is the future value of Bitcoin compared to the alternatives. If an asset can appreciate more than 1,000% in less than a year, can it depreciate just as quickly?
Finite Supply
To the extent the two assumptions above hold true, I doubt Bitcoin will ever fall back to its year-ago value. There is a finite amount of Bitcoin, of which roughly 90% has already been “mined” (issued).
As demand for Bitcoin increases while its supply dwindles, its price will go up. The supply side of the equation is fixed, so it is the demand side of the pricing formula that will determine its future value.
There won’t be much demand coming from individual investors. A single Bitcoin costs around $50,000 these days. That’s beyond the reach of most households, but easily affordable for a corporation with billions of dollars of cash on its books.
Elon Musk, founder and CEO of electric vehicle maker Tesla (NSDQ: TSLA), recently announced that he bought $1.5 billion of Bitcoin with company funds. In a recent tweet, the billionaire entrepreneur acknowledged that the price of Bitcoin does “seem high.”
Musk also opined that “Money is just data that allows us to avoid the inconvenience of barter.” In his opinion, Bitcoin minimizes the risk of “latency & error” in storing wealth in a currency until it is spent.
In that case, it makes sense for a large corporation to use Bitcoin as an alternative to cash. But back to my original question: Is that a good reason for you to buy stock in a company?
Square, Hip and Trendy
That question came to mind last week when financial services firm Square (NYSE: SQ) released its 2020 Q4 and full-year results. At the same time, the company announced that it recently bought $170 million of Bitcoin. Combined with a previous purchase of $50 million, Square holds approximately 5% of its cash in Bitcoin.
Unfortunately for Square, neither its fourth-quarter results nor its Bitcoin transaction impressed Wall Street. The following morning, its share price dropped 10%. However, the stock was still up 50% over the past six months so a price correction of that magnitude only puts the stock back to where it was trading three weeks prior. At the same time, shares of Tesla fell below $700 after cresting $900 one month earlier.
The fact that both stocks dropped shortly after their Bitcoin purchases should not be blamed on those transactions. However, it is apparent that the emergence of Bitcoin as an asset on their balance sheets did not help them, either.
I expect more companies will boldly pronounce their Bitcoin purchases in the weeks and months to come. The cryptocurrency market is hot and nobody wants to be left out. Especially in the tech sector, where being trendy is not only hip but necessary to remain relevant. As other companies announce their Bitcoin purchases, I expect its price to climb higher.
That will drive up the value of Bitcoin on the books of the companies that own it, but not enough to influence their share prices. Until that currency is spent, there is no way for analysts to judge what the return on those investments might be.
For that reason, it does not make sense to buy stock in a company simply because it owns Bitcoin. The right reason to own a stock is the same as it has always been. You believe that business will thrive, which eventually will result in higher earnings that will drive its value higher.
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