Fool disclosure: I spend a lot of time on Twitter -- probably too much time on Twitter -- but there are side benefits even to a bad habit. Case in point: When rapper Zuby asked his fans for investing advice last week, his tweet jumped right out at me.
How would you invest $250,000?-- ZUBY: (@ZubyMusic) March 17, 2022
Of even greater interest were the more than 7,000 replies that came back in response to this innocent question. One of the most popular of these replies caught my eye as a model of diversification... and potentially, of irrational exuberance as well.
$70K Bitcoin-- Sirjeff Dennis🇹🇿 (@Sirjeff_D) March 17, 2022
$10K Nio Inc
$10K Terra Luna
To give credit where credit is due: This portfolio, suggested by Tanzanian cryptocurrency investor Sirjeff Dennis, encompasses a good dozen ideas (if not necessarily a dozen good ideas). Thus, it offers at least some level of diversification to minimize the potential losses from any one investment.
On the other hand, eight of these suggestions -- fully two-thirds of the portfolio -- are allocated to the single, questionable asset class of cryptocurrencies. And if you count carefully, you might also notice that Sirjeff's top three investing ideas allocate more than half his hypothetical $250,000 (which is to say, $135,000) among just three positions: Bitcoin (BTC 0.10%), Tesla (TSLA -4.23%), and Nvidia (NVDA 1.45%).
And I wonder: Is that wise?
Why that might not be wise
Now, I certainly understand the attraction -- both to investing in cryptocurrency in general, and to investing in Bitcoin in particular. Over the past couple of years, crypto has provided some remarkably good profits, in very short periods of time, for many investors stuck at home trading on their PCs throughout the pandemic. Bitcoin itself, the granddaddy of cryptocurrencies, has rocketed from lows below $6,000 to highs north of $65,000. It's given back some of those gains, of course, but was still recently spotted near $44,000, resulting in a two-year profit close to 650%.
Similarly, returns from Nvidia stock are in the neighborhood of 330% over the past two years.
And Tesla is up more than 940%!
So yeah, when thinking of investments with powerful profit potential, I can see why Bitcoin, Nvidia, and Tesla might spring to mind. Problem is, as investment advisors keep telling us, "past performance is no guarantee of future results."
Investors in Bitcoin today, for example, who hope to reap the same profits that investors in Bitcoin two years ago earned, are betting that by April 1, 2024, one Bitcoin will be worth approximately $330,000. At that point, all the Bitcoins in the world, combined, would be worth about $6.3 trillion.
That's about 15% of the total value of all currencies present in the world today -- and three times more than the volume of all U.S. dollars currently in circulation worldwide. I'm not saying it's impossible, but for a "currency" that most people have never actually used in real life, I think it's a bit unlikely.
Nvidia investors have a similar problem. Unlike Bitcoin, Nvidia stock represents ownership of a business that is growing -- nay, thriving -- and creating more and more value with each passing day. As such, I consider an investment in Nvidia superior to an investment in Bitcoin.
That being said, it's still possible to overpay for Nvidia. Consider:
At current valuations, Nvidia stock has a market capitalization of about $694 billion -- 71 times the $9.8 billion in profit it earned last year. Analysts who know the stock well, however, anticipate that over the next five years, Nvidia will grow its earnings at only 21% annually, which works out to a price-to-earnings ratio of 3.4 on Nvidia stock.
Ordinarily, value investors consider a P/E ratio of 1.0 or below to be cheap, and P/E ratios of more than 2.0 expensive. Again, I wouldn't say it's impossible that Nvidia will grow 330% over the next two years, as it did over the last two. If that were to happen, however, while earnings grew only 21% per year, it would mean that in two years' time, Nvidia would have a market capitalization of nearly $3 trillion versus net earnings of only $14.3 billion. That works out to a P/E ratio of 210 times and -- call me crazy if you like -- I kind of doubt investors are going to be willing to pay that kind of a price for Nvidia.
Last but not least, there's Tesla. America's favorite electric car company has finally proven it can earn and maintain a profit. More than that, analysts polled by S&P Global Market Intelligence believe Tesla will keep on growing its profits at 39% per year over the next five years. But again -- assume they're right about the earnings growth, and assume the stock also grows as fast over the next two years, as it did over the last two years.
For Tesla's stock price to grow another 940% through March 2024, while its earnings grow only 39% per year (that works out to 93% total growth in profits over two years, by the way), Tesla's market cap would need to rise from $1 trillion today (189 times earnings) to about $10.4 trillion two years from now -- even as Tesla's earnings grow only 93% to $10.6 billion.
And Tesla would end up with a P/E ratio of 981.
Could it happen? In this crazy world we live in, anything is possible. Would I bet $135,000 of real money on it happening, however? Not on your life.