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Don’t Apply Old School Valuation Metrics to New School Ethereum

A friend of my wife’s business partner bought Ethereum (CCC:ETH-USD) earlier this year when it was trading around $1,000. Still holding as it’s blown through $4,000, I’d love to be able to tell the friend to sell, but I’d have very little ammunition to provide him.

The reality is, if you’re like me and cling to old-school valuation metrics such as free cash flow (FCF), they aren’t going to help much when it comes to valuing the cryptocurrency. Old school doesn’t work in this instance.

So, if you’re getting a case of FOMO (fear of missing out), you might want to have a beer and chill. Under no circumstances are you going to be able to come up with a valuation scenario that makes sense.

Here’s why.

You Can’t Value Ethereum

Before you email me a million examples of people who have supposedly done so, let me quote a Medium article from October 2020 entitled “How to Value Ethereum Today: DeFi, The Protocol Sink Thesis and Beyond.” The piece was produced by the Norwegian Block Exchange, Norway’s leading crypto exchange.

“While all sorts of services can be built upon the Ethereum blockchain, then upon each other, final settlement can only be done in Ether,” the article states.

“In other words, at some point, all Ethereum services have to send Ether transactions to pay to keep themselves running. Due to this, any growth on top of the network always sinks down to its foundation, where the most value ends up being accrued over the long-term.”

The piece says that if Ethereum is a global public good, by extension, that would suggest Ether is also a global public good. And anything that is a global public good must possess tangible value.

I encourage you to read it. It definitely gets you thinking about Ethereum and its position in the world. 

And don’t get me wrong, I’m a proponent of Ethereum. In early April, I said that if I could only own one cryptocurrency and choices were Ether or Bitcoin (CCC:BTC-USD), 10 times out of 10, I’d go with the former. The utility is everything. 

However, that still doesn’t give me an intrinsic value.

InvestorPlace to the Rescue?

InvestorPlace’s Alex Sirois made an interesting argument in mid-March why Ethereum may soon overtake Bitcoin as the world’s most valuable cryptocurrency. At the time, ETH was trading around $1,700, well below the more than $50,000 price tag to buy one BTC token. 

Sirois goes on to discuss the flippening, a collection of eight metrics that includes market capitalization. The eight metrics point to a time when Ethereum should overtake Bitcoin. In March, Ethereum was two-thirds of the way there.

My colleague makes the argument that the bigger the market cap, the stronger the company. I wish that were true, but we all have examples of large-cap stocks that are worth a lot more than they should be, merely because they pay consistent dividends and have major followings. 

But I digress. 

His point is that we need to monitor how close Ethereum is to passing Bitcoin from a market cap valuation perspective. The gap was $715 million in March. As I write this, it’s $549.7 million — it will be hard not to consider the cryptocurrency something of real value. 

Even more so, if companies start buying ETH for their balance sheets, it’s all over but the crying.

The Bottom Line

 I’m someone who leans on free cash flow generation when analyzing non-financial stocks. Last October, I wrote “10 Undervalued Stocks to Buy,” a collection of 10 stocks from the Pacer US Cash Cows 100 ETF (NYSEARCA:COWZ) with tremendous FCF generation.

In the seven months since, the 10 stocks averaged a 22.7% return, not including dividends, compared to a 17.5% return over the same period for the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).

Company NameOctober 12, 2020May 11, 2021Return Percentage
Altria (NYSE:MO)$40.45$50.4324.7%
Best Buy (NYSE:BBY)$118.33$121.672.8%
CVS (NYSE:CVS)$59.72$84.3741.3%
Discovery (NASDAQ:DISCA)$22.34$36.7864.6%
Gilead Sciences (NASDAQ:GILD)$64.55$67.224.1%
Intel (NASDAQ:INTC)$53.88$55.042.2%
Kroger (NYSE:KR)$34.63$38.4210.9%
Lennar (NYSE:LEN)$83.95$103.4523.2%
Target (NYSE:TGT)$164.57$209.2427.1%
Tyson Foods (NYSE:TSN)$58.97$79.4425.8%
SPDR S&P 500 ETF Trust$352.43$414.2117.5%

How do you think ETH did? It’s up approximately 998%.

Now, I could give you another 10 stocks with strong free cash flow that would do well over the next 3-5 years based on FCF continuing to grow while maintaining a reasonable FCF yield, but I have no way of valuing Ethereum other than to say it’s worth something.

In 2018, Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) CEO Warren Buffett discussed the concept of “intrinsic value” while discussing the changes in its share repurchase policy.

“The tough part is coming up with the intrinsic value. There is a lot more to intrinsic value than P/E,” Buffett stated in July 2018. He continued that it isn’t possible to calculate specific decimal values “or anything of the sort.”

But at least with the intrinsic value, you’ve got a shot at getting close. With Ethereum, you’ve got bupkis.

Does this mean you shouldn’t buy ETH at these prices? It does if you like certainty.

By Will Ashworth