Is art an investment?

No.

That was simple, let's move on.

Wait a minute, some of you are saying, not so fast. Don't all kinds of hedge fund managers buy and sell art for huge profits? And locally in Vermont, didn't an elementary school find a Norman Rockwell in storage in the basement - wasn't that worth something?

First, we have to clarify what we mean by "financial investment." Art yields all kinds of return in terms of quality of life, expression, entertainment, and healing - all investments of a different sort. I am a huge supporter of more art in schools and life in general. (As an aside, artists can make great investors because many of them are trained to draw or paint what exists, not what their brain tells them should exist.)

Financially, though, one can make the argument that an investment has to be valued on the cash flow it produces, technically called "discounted cash flow." If something produces no cash flow and will not in the future, the discounted cash flow = 0. Hence the asset has no value.

You might then look at a company like Google and think "but Google pays no dividend. With no payments to its shareholders, it should be worth zero instead of close to a trillion dollars."

But Google does have cash flow, and retained earnings. It just doesn't pay them out to the investor currently. Instead it piles them up in its own bank accounts. While the argument exists that, in theory, the investor might never get a dividend or a payment, the cash on the balance sheet belongs to the shareholders.

In other words, the difference between, say, The Starry Night and Google is that if you owned The Starry Night, a future buyer would have to get "starry eyed" and pay you more for it than the price you paid. But Google continuously produces cash - and this cash forms the basis for a valuation.

You can use this framework to think about other financial investments. If the investment has no present cash flow or possibility of future cash flow, a financial return will depend on someone assigning it a future value based on something other than the numerical value of cash. That can turn into more of a belief game than a numbers game.

Dan Cunningham

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