When Calculating Value to Challenge the Price, Do Not Put Price in the Calculation. This principle in chapter 1 warns about value calculations that include market prices: They are circular. Chapter 2 shows that several common valuation techniques violate this principle. But there is a more subtle feature: Accounting sometimes includes market prices in financial statements so accounting for value based on these financial statements also violates the principle.
Here is an exhibit: MicroStrategy Incorporated (again)
MicroStrategy holds a large stock of Bitcoin. On the day in December 2024 when Bitcoin reached a $100,000 price for the first time, the firm’s Bitcoin holding was valued at $40 billion and the firm’s equity market value stood at $90.5 billion. For 2024, the stock price was up 512%.
MicroStrategy carried its 252,220 Bitcoins as their cost of $6,850.8 million on its September 2024 balance sheet. However, that was about to change. The Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2023-08, Intangibles—Goodwill and Other—Crypto Assets (Subtopic 350-60): Accounting for and Disclosure of Crypto Assets (“ASU 2023-08”). ASU 2023-08 requires crypto assets (including the company’s bitcoin holdings) to be measured at fair value in the balance sheet beginning January 2025, with gains and losses from changes in the fair value of such crypto assets recognized in net income each reporting period.
Beware: this new accounting requirement puts speculative Bitcoin prices in the balance sheet. If it were implemented in 2024, the Bitcoin holding would be booked at $40 billion rather than $6,850.8 million. Is that a balance sheet that a value investor wants to anchor on? No: That puts price into the accounting. It is a speculative value and the value investor separates speculation from fundamentals in order to challenge speculation in the market price.
The new accounting would also book the huge Bitcoin price appreciation in 2024 as earnings. Valuation is based on expected future earnings. Are these speculative profits a good indication of future profits. We will see when it comes to Bitcoin, but profits from speculation often end with disappointment, as with the fall in Bitcoin prices in 2022.
The proposed accounting is an application of fair value accounting more generally. It is applied to investment securities, derivatives, and some of bank’s mortgage loans. It sometimes helpful but requires scrutiny: Beware!
