A business is a depreciating asset

When I was about to graduate college my dad took me car shopping.  He wasn't one for financial advice, probably because his own financial situation wasn't that great.  While test driving a used Honda he uttered the only financial wisdom I'd ever heard from him.  He said "Don't use debt to finance depreciating assets, only use debt to finance things that appreciate."  He expanded to explain that cars depreciate, but since I was a poor college kid I'd have to break this rule and finance the car anyways.

I think back to that discussion often, maybe for its simplicity, and maybe for the significance in my life.  But I think there is a larger aspect to it that applies to markets.

Often stocks are discussed as assets.  On your personal balance sheet cash and stock you own are assets held against any debt you owe.  Stocks are person assets.  We think of assets as things that appreciate because of their value.  Non-financial assets are things like fine wine, land, artwork, rare antiques.

There aren't many assets that appreciate by themselves.  Land and art come to mind, but that might be it.  Otherwise almost everything is constantly depreciating, and that includes the companies that hide behind stock certificates.

In many ways cars are a perfect analogy to companies.  A company requires constant maintenance and upkeep to generate revenue and profits.  You need to fuel a company with sales in order to keep it moving forward.  If driven long enough most moving parts of a car will wear out and need to be replaced.  The same is true for a company, machines break, computers need to be upgraded, processes and techniques change.  Given enough time a company will reinvent itself.

The ownership profile differs depending on the type of vehicle you own.  All vehicles are created to get from point A to point B.  Just like all companies are created to earn a profit.  But owning a 1982 Chevy Cavalier is a lot different than a new Honda Civic.  Sure, both are compact commuter cars, but keeping the Cavalier running will require a lot more care and feeding compared to the brand new Civic.  Yet when the owner steps out of the vehicle at the destination the same task was accomplished.  It doesn't matter whether the Cavalier or the Civic carried them there, they're at their destination.

The key differentiator is whether the maintenance is worth it.  If both vehicles get you to your destination and the end result is the same then why purchase one over the other?  It all comes down to price and preference.  Where a new Civic costs around $20k for a sedan you can find an old Cavalier for around $1k.  The price is the determining factor.  If both get someone to their destination is it worth paying 20x for the same experience?

As mentioned earlier both are depreciating, both require maintenance, and both have the possibility of breaking down.  If the Cavalier was maintained perfectly and lived it's life in California or the Southwest without rust it's possible that it might be just as reliable as the Civic.  But if the Cavalier prowled the rust belt then it's not impossible to imagine dumping $2-3k into the car each year in replacement parts.

If you let both cars sit without any maintenance then within a few years they'll be worth a fraction of their current value.  The Cavalier by nature of being older and cheaper will depreciate less than the Civic, but both will drop.

Let's take this analogy to the business world.  If a company isn't constantly reinvesting in their own business the value will start to fall dramatically.  There is a narrative that companies invest heavily in the beginning and then can back off investment.  Just like a car, you can hold off on maintenance, but eventually you're looking at a large bill to replace something significant.

I'd argue that if a company is investing heavily in the beginning to remain competitive they will need to continue to invest heavily.  If you own a company that requires constant maintenance why would eliminating that maintenance be a good thing?  Likewise there are some companies that run really well without as much investment, and as long as a base level of investment is satisfied they should continue like this.

Just cars both types of companies can be financially viable, but it depends on the price paid.  Ironically in our current market the companies with the highest maintenance needs are priced the highest whereas companies with the lowest maintenance needs are priced low.  This doesn't make sense.

As you look for investments, make sure you don't pay 2018 Honda Civic prices for a 1982 Chevy Cavalier.

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