By Alex Tapscott
The first-ever stock market popped up spontaneously in Amsterdam in 1602, as a venue to trade shares in the newly incorporated Dutch East India Company, one of the first of a novel breed of organization known as the Joint-stock company. Joint stock companies in England and Netherlands were a big innovation at the time: they pooled risk and pursued large undertakings like transatlantic voyages, which had a high likelihood of failure. In the early 1800s, companies took another great leap forward with the invention of the limited liability company which made it easier to pool large amounts of capital to pursue huge industrial undertakings like building a railroad. The LLC is now widely regarded as a foundational innovation to modern capitalism, along with the steam engine and railroad locomotive. In 1926, The Economist wrote that the “nameless person” who invented the concept of limited liability deserved “a place of honour with Watt, Stephenson, and other pioneers of the industrial revolution.”i
Despite the long and illustrious history of the corporation, securities analysis - how we determine the worth and thus the suitability of the shares of a company or some other asset as an investment - is relatively modern. Benjamin Graham and David Dodd wrote their pioneering book Security Analysis, the sacred text of value investing, only in 1934.
Good Companies Are Not Always Good Investments
Graham Dodd took a while to catch on. The 1960s was a decade when many Wall Street talking heads were parroting the virtues of “The Nifty Fifty,” a group of the biggest and best run companies in the world, such as Kodak, The Walt Disney Company, JCPenney, and IBM. These businesses dominated their respective industries at a time when the American economy was the envy of the whole world. Why wouldn’t they make good investments? Investors were told to buy these stocks at any price, valuation be damned, and as a result they traded for a while at 50x their earnings, vs. a historical average of 19x!ii
Eventually, the Nifty Fifty valuations came back to earth. The Arab Oil embargo of 1973 helped pop the bubble in stocks with the Dow Jones falling 45%.iii Market participants learned one of Graham and Dodd’s core lessons the hard way: a good company does not always make a good investment. You need to also pay attention to its valuation. This is something Graham-Dodd disciple Warren Buffet has always understood, which is why he’s been able to compound the book value of Berkshire Hathaway by 20% per year compared with 10% for the S&P500.
Today, investing is a far more crowded field, with many sophisticated actors, and securities analysis is big business, practiced by Wall Street’s largest and most profitable firms. Trillions of dollars a day in trades occur based on recommendations from analysts who update their valuation and price targets based on new information that comes in a steady deluge.
Digital Capital and Securities Analysis
But what happens when companies give way to new kinds of digitally native organizations? For starters, today’s practitioners will need to do some homework to not become redundant. They are a clever bunch so that does not worry us. More pressing is that we need an entirely new framework for valuing these new kinds of organizations, enterprises and protocols. After all, if chartered companies were foundational to the mercantile age, and limited liability corporations to the industrial age, then user-owned networks – protocols, application-specific blockchains, layer-2 networks and so-forth, may come to define the next era of the digital age. The early era of Web3 bears this out: most of the leading DeFi protocols, for example, are organized as internet-native decentralized autonomous organizations (or DAOs).
Buffet was the vanguard of a new group that made outsized risk-adjusted returns (known in industry jargon as Alpha) from identifying mispriced assets. Today, similarly, there is an opportunity to make outsized returns in digital assets from identifying value. But how?
If you’re interested in learning more about valuing digital assets, check out our two most recent episodes of DeFi Decoded, and stay tuned for more research from the Ninepoint Digital Asset Group.
DeFi Decoded: How Should We Value Digital Assets
DeFi Decoded: Ethereum Goes Ultra-Sound. Is ETH the New Digital Gold?
