Should You Buy Fine Art as an Investment?

I’ve never forgotten the details of my first purchase of an original oil painting, “Going Home” by cowboy artist Jimmy Cox in 1978. The scene is a panorama of a barren, West Texas prairie at dusk, the sky filled with a smattering of light cirrus clouds glowing purple from the setting sun. Three weary cowboys on their exhausted horses are in the forefront of the painting, the effects of their long workday evident in the slumped shoulders of the men and drooping heads of the horses.
While I’ve purchased other paintings and bronze sculptures over the intervening years, no piece of art has replaced my affection — even love — for that painting. It has occupied center stage in my offices for almost 40 years. The scene reminds me of my early childhood in Texas, the satisfaction of physical work, and the persistence required to build a future in any place. I recognize my father, grandfather, and uncles in the riders’ postures and expressions.
Art has always moved us and evoked memories and dreams of other times and places. British playwright George Bernard Shaw is alleged to have said, “You use a glass mirror to see your face; you use works of art to see your soul.”
Unsurprisingly, some are eager to monetize our attraction to fine art, viewing it as a new investment class alongside stocks, bonds, and gold. Investment-grade art can deliver an annual return of 10% or more, according to its advocates. Some say its movement is counter-cyclical to the movement of equities and thus can stabilize a portfolio during periods of volatility. Laurence Fink, CEO of Blackrock Financial, one of the world’s largest fund managers, claimed in a Bloomberg interview that contemporary art is a “serious” asset class and “one of the top two greatest stores of values internationally.”
Is fine art an appropriate investment for everyone? Should you forego the purchase of a stock or bond to buy a painting or invest in an art fund? How does ownership of art differ from traditional investments like stocks, bonds, real estate, or gold? Let’s take a look.

Why Art Attracts Us

Jean-Luc Godard, French film director and father of the New Wave film movement, claims, “Art attracts us only by what it reveals of our most secret self.” Art is the physical expression of thoughts and emotions. Creating artwork is intensely personal, with the artist expressing his unique perspective of the world — both real and imaginary — around him.

Research by neurobiologist Semi Zeki of the University College in London found that viewing art triggers a surge of dopamine — the chemical neurotransmitter that makes us feel good — in the brain. The feelings associated with art, Zeki found, were similar to those associated with romantic love.
Fine art — paintings, sculptures, drawings, photographs, and prints — transcends time and space. The perfection of physical beauty captured by Michelangelo’s “David,” the angst of Edvard Munch’s “The Scream,” and the mystery behind the Mona Lisa’s smile have fascinated viewers for centuries. However, purchasing art to make money is a relatively modern development.

Fine Art as an Investment

For centuries, the ownership of fine art was limited to society’s elite. Only the wealthy — aristocracy, churches, governments, and very successful tradesmen — could afford to purchase or sponsor a piece of art. Displaying a painting or sculpture in a private setting was physical evidence of one’s status. Steven Pritchard, writing in Culture Matters, notes that as early as the Renaissance, ownership of art signified “status, influence, power, and wealth.”
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Is it Time for A Media Room?

Having a private cinema in your home was once considered the ultimate luxury, available only to movie moguls, film stars, and industry titans with access to restricted film libraries. Joseph Cali, a theater designer and installer for actors George Clooney, Matt Damon, and Tom Cruise, estimates that the minimum cost for a top-of-the-line home theater is upwards of $500,000 — and it can reach millions of dollars depending on amenities.
While such extravagance is beyond the desires and checkbooks of most people, advances in technology have expanded opportunities for middle-income Americans to enjoy the experience of a private video and audio entertainment space.
Today, private media rooms are designed and constructed to replicate the experience of viewing movies and TV shows in a commercial theater in a smaller, more comfortable environment. Most have viewing screens of 16 to 18 feet long with elaborate sound systems and comfortable seating. If you have gamers in your family, a media room can also enable them to play their video games on the big screen.
Is it time for you to consider adding a media room to your home? Let’s take a look at what it entails and how to decide if it’s right for you.

Benefits of a Media Room

The decision to add a media room is rarely based on financial benefits, such as its expected financial return when the house is sold. While these things are a consideration, the real benefit of a media room is the pleasure that you and your family will receive from it.
Of course, this can be difficult, if not impossible, to quantify. A four-member family spends almost 1,785 hours annually watching television; is the additional comfort and control of a home media room worth $1 per hour or $5? It’s hard to say for sure.
What we do know is that for most people, viewing films, playing video games, or listening to music is more pleasurable in their own homes than in a public venue. Poll after poll indicates that the majority of Americans prefer video entertainment in their homes due to their control over the following factors.

1. Content

A home media room allows the viewer to pick what to watch and when to watch it, including giving them the ability to pause content for bathroom breaks or rewind if they missed something. The plethora of available content providers means that viewers can select from a wide variety of content, including old and new domestic and foreign films, TV shows, sporting events, and documentaries.
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Initial Coin Offerings – Risks and Rewards

A friend of mine, a big fan of the Harry Potter series, recently planned to launch an initial coin offering (ICO) to fund a new Quidditch sports league. His new “Quidcoins,” valued at 0.009 bitcoins (BTC), would be exchangeable for discounted admission and food at select National Quidditch games around the country. He hoped to raise a maximum of 2,000 BTC ($11,000,000) over a 28-day offering period.
Unfortunately, before my friend could organize his company and raise money, he discovered that a group in Britain was in the midst of offering their own QuidCoins, named after the slang word for the British pound. While my friend was disappointed to find the name taken, perhaps it was for the best; despite sponsors’ hopes, QuidCoins traded for less than three months in 2014, according to CoinMarketCap.
ICOs promise big profits to investors, but with a failure like QuidCoin’s possible at any time, are they worth the risk? If you’ve been considering participating in an ICO, here’s what you need to know.

What Is an ICO Financing?

Entrepreneurs have historically financed their ideas by offering equity interests — or investment securities — in their ventures to external investors. Due to the abuses and corruption of financiers in the 1920s, Congress passed the Securities Act of 1933 and created the Securities Exchange Commission (SEC) the following year to enforce the Act.
In the decades since, the process of raising money from the public through an initial public offering, or IPO, has become well-established. Regulations dictate how the offering process must proceed, who is eligible to participate, when an offeror must provide information to potential investors, and what information they must provide. Failure to follow regulations can result in severe financial liability for the sponsors of an offering, including civil and criminal penalties.
An ICO is a similar fundraising tool in which an offeror sells futures in a cryptocurrency that does not yet exist. ICOs are designed to avoid the regulations that protect investors when buying or selling traditional investment securities. While an IPO must include an extensive prospectus, there are no regulations outlining what information must be provided to prospective investors in an ICO. Each offeror determines what, if any, details will be delivered and when.
Most ICOs have a website or white paper justifying the benefits of the investment, but they do not have an existing product. Offerers are startup operations, and the funds raised through the ICO will finance the development of the product — in this case, the cryptocurrency.
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What is a P/E Ratio and Why Does it Matter?

Stock investors are constantly searching for ways to determine whether a stock is under- or over-valued. Logically, they seek to buy securities in companies that are under-valued and sell the securities of companies that are over-valued. The Price Earnings (P/E) Ratio is a common way to quickly assess how investors value a company based upon its future earnings projection.

Calculation of P/E Ratio

The P/E ratio is the result of dividing the common stock market price by its reported or projected earnings per share. For example, the common stock of XYZ Corporation sells for $22 per share. The latest reported annual earnings are $1.75 per share. The P/E ratio of XYZ would be 12.6 ($22 divided by $1.75). Price earnings ratios are used to compare different companies or the same company over different time periods.
Companies with higher P/E ratios are expected to have higher rates of future earnings growth. For example, web-based Amazon (AMZN) had a P/E ratio higher than its brick-and-mortar competitor Walmart (WMT) even though the latter’s earnings per share (EPS) were more than seven times greater than Amazon’s in 2015. Simply stated, investors are willing to pay more today for a dollar of Amazon’s earnings than a dollar of Walmart’s earnings because they believe Amazon’s earnings per share in the future will grow faster than Walmart’s.
P/E ratios can vary substantially based upon the earnings components used to calculate the ratio. Most analysts seek to understand and project operating earnings, rather than total earnings that may include extraordinary events unlikely to recur.
In the example of XYZ, the reported earnings of $1.75 per share included the sale of a division that added the equivalent of $0.30 per share to the final earnings result. Securities analysts typically deduct the financial impact of extraordinary events to arrive at a true operating profit. In this case, reported earnings of $1.75 would be reduced by $0.30 to get operating earnings per share of $1.45 and the newly calculated P/E ratio would be approximately 15 ($22/$1.45).
Price earnings ratios can also vary according to three factors:

  • Trailing Actual Earnings. Earnings may be for the latest reported calendar year or adjusted as each quarter is reported. For example, a year includes quarters 1, 2, 3, and 4 of the most recent year. When the first quarter of the new year is reported, the analyst would omit quarter 1 of the previous year and add quarter 1 of the current year so the annual earnings would include quarters 2, 3, and 4 of the previous year and quarter 1 of the current year. This approach ensures that the analysts are using an earnings figure for the most recent 12 months.

  • Projected Earnings. Sometimes referred to as a “Forward P/E,” the earnings figure is based upon an analyst’s estimated earnings per share over the next 12 months. The projected earnings may be the opinion of a single analyst or a consensus of a number of analysts. It is important to know who is making the estimate and that person’s qualifications to ensure that projected earnings are realistic.

  • Combination of Actual and Projected Earnings. Some analysts may use two quarters of actual earnings and two quarters of projected earnings to arrive at an earnings per share number.


Testing the Validity of the Price Earnings Ratio

Theoretically, companies with higher rates of annual earnings growth have higher P/E ratios. From time to time, investor optimism pushes the price of a security to unrealistic highs with expectations of excessive growth. Using the Price/Earnings Growth (PEG) ratio is a quick and easy way to determine whether the P/E ratio is justified or if a security is over-, under-, or fairly priced based upon your expectation for its average annual growth during the next five years.
The PEG is calculated by dividing the Price Earning ratio by the projected annual five years earnings growth (a three-year period can also be used if desired). For example, Company B’s stock selling at a 13 P/E with an estimated annual growth rate of 25% per year would have a PEG of 0.52 (13/25) while Company A’s stock selling at a 10 P/E with an estimated annual growth rate of 25% would have a PEG of 0.4 (10/25). Analysts consider a ratio less than 1.0 as under-valued, equal to 1.0 fairly valued, and over 1.0 as over-valued. While the shares of both companies are undervalued based upon their projected earnings growth, Company A would be the better purchase due to its lower PEG ratio.
As with all indicators, neither the P/E nor the PEG are completely reliable, especially since stock prices are rarely rational in the short-term. It is this volatility that provides opportunities to buy and sell.
Nonetheless, it’s important to recognize that companies with very low earnings can provide skewed results. It is much easier for a company earning a million dollars to grow 100% per year for five years to $16 million than a company earning $100 million to grow to $1.6 billion in profit. When establishing a projected earning growth rate, consider your own common sense as well as any public estimates of growth from reliable analysts.

Limitations of the P/E and PEG Ratios in Analysis

Both ratios are simple and easy to calculate, but are best used as general indicators of value due to their superficiality. Their limitations in deterring value include the following:

  • Calculations of Company Earnings Are Complex and Frequently Managed by Corporate Executives. Accounting and tax rules are complicated and constantly changing, making comparisons between earnings of different periods and companies difficult. Since the market typically rewards higher P/Es to companies with a trend of consistent earnings growth than companies with erratic earnings, corporate executives try to manage reported earnings to meet investor expectations and maintain high stock valuations.
  • High Growth Rates Cannot Be Extended Indefinitely. Extraordinary earnings growth is difficult to achieve as companies mature. Competitors recruit company employees, leapfrog technologically, and capture market share from industry leaders. Additional suppliers generally reduce product or service prices and profit margins. As companies grow larger and grow staff, reacting to changing market conditions is more difficult, making them more vulnerable to those very market conditions.
  • P/E Multiples Tend to Fall Over Time. Earnings projections tend to be optimistic. When earnings projections are not met, ratios tend to contract.
  • Some Companies Are Not Valued Based on Their Earnings. Entrepreneurial companies like Facebook (FB) and Amazon spend heavily in their early years to capture a dominant market share, thereby delaying earnings. Natural resource companies invest heavily in exploration activities to find assets that will be converted to cash in future years. Since those activities are generally expensed in the year they occur, the company produces accounting losses even though assets may grow signficantly.
  • Financial Leverage Impacts Earnings. P/E ratios consider only the equity of a company, not its entire capital base. Leverage, using debt in the capital structure, increases shareholders’ risk since debt has a multiplier effect when earnings on the borrowed capital exceed the cost of that capital. Conversely, when the rate of earnings is lower than the cost of borrowed capital, shareholder losses are exaggerated. Looking at a P/E ratio without considering the debt owed by the company often leads to invalid results.
  • P/E Ratios May Be Misleading. While a low P/E ratio may indicate an under-valued, over-looked opportunity for profits, it can also mean that the company’s earnings will decline in the future and astute investors are selling the stock to avoid losses. Relying on P/E ratios alone to buy or sell stock is a risky and foolish practice.

Final Thoughts

P/E ratios are excellent tools for a superficial analysis such as determining which company in an industry to further investigate or selecting one industry over another. Nevertheless, it is important to ascertain the underlying reasons for a multiple before making an investment decision.
In the short-term, stock prices can be very volatile since they reflect investor hopes and fears. For example, a suspected change in an analyst’s opinion or rumors about the economy, an industry, a company, or its competitors affect stock prices and P/E multiples whether valid or not. P/E and PEG ratios should always be used with other metrics before taking investment action.