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The problem with bitcoin’s own ‘P/E’ valuation measure

As the perceived worth of a single bitcoin criss-crossed its..

As the perceived worth of a single bitcoin criss-crossed its way around the $10,000 (£7,455) mark for much of last week, on The Value Perspective blog, we revisited articles from 20 June 2017 and 20 October 2017, when one bitcoin respectively bought you $2,779 and very nearly $6,000.

Each time our primary concern was there was just no way of assessing its true value – but could we have been wrong?

Assessing value

One of the most basic ways of assessing how a company is being valued by investors is to look at its price/earning (P/E) ratio – that is, its share price divided by its earnings-per-share – and comparing that, for example, with history, with its peers or with the wider market.

Now it turns out aficionados of bitcoin and other so-called ‘crypto assets’ have started to refer to their own kind of P/E ratio.

At first glance this might sound odd – after all, bitcoin and the others do not actually produce any earnings – but, on closer investigation … well, it is odder still.

Aficionados of bitcoin and other so-called ‘crypto assets’ have started to refer to their own kind of P/E ratio.

The measure’s actual name is the Network Value to Transactions (NVT) ratio, which – to take bitcoin as an example – is essentially the market value of all the bitcoins in the world divided by the US dollar value of transaction activity.

So the first curious things about the NVT is it includes a reference to the value of the crypto-asset on both sides of the equation, which is redundant.

Another curiosity is that the ratio effectively boils down to considering the value of an asset relative to how much speculation there is in it – meaning, if you want the NVT valuation of a bitcoin to fall, you just need to trade it more and more.

The metric fuels more speculation and more interest

This may of course be why bitcoin investors are so keen on the metric – the more they speculate, the ‘cheaper’ their favourite asset becomes and the more they can encourage fresh interest in the market.

As an example, according to Woobull.com, the bitcoin’s NVT stood at around 60x at the time of our June article, close to 100x at the time of our October one and is back down to around 60x now.

While its advocates may argue the NVT ratio is similar to the P/E ratio, it is actually akin to looking at the market capitalisation of a company – put simply, its size – divided by the value of the shares being traded daily.

Doing the maths on three arbitrary well-known companies tells us GlaxoSmithKline, Centrica and Proctor & Gamble are respectively on 550x, 193x and 321x – in other words, just random numbers.

So we would argue that, while the NVT may be gaining greater currency (sorry) among crypto-asset investors, it does not tell anyone a great deal about anything – or at least not about the asset under consideration.

It might, however, tell us something about the human race’s inherent need for reassurance they are not doing something silly.

  • Ian Kelly is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.

Important Information: The views and opinions contained herein are those of Ian Kelly and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

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