In 1635, somewhere in what was known then as the Dutch Republic, 40 tulip bulbs sold for 100,000 florins. At a price of 2,500 florins per bulb, the market for tulips was entering an intense mania that wouldn’t peak until 1637, according to Charles Mackay’s 1841 book Extraordinary Popular Delusions and the Madness of Crowds. For scale, a skilled laborer at the time earned 350 florins a year.
This speculative mirage, known in Dutch as Tulpenmanie—and which ended with tulips being worth next to nothing—was one of the first bubbles in history to be chronicled. Mackay reported that, at the height of the frenzy, the prized Semper Augustus tulip bulb sold for the price of 12 acres of land. Though some economic historians have questioned the scope of Mackay’s account, there’s no doubt that Dutch wagerers made (and then lost) a harrowing amount of money buying and selling futures contracts on tulips.
Given the insane nature of bidding seven times someone’s salary for a tulip bulb, it’s natural for people to disbelieve the tale. But surrounded as we are today by speculative manias in non-fungible tokens (NFTs), cryptocurrencies, NJ delis, and the like, it becomes easier to picture 17th century tulip lunacy. In fact, history is full of bubbles in dubious collectibles and trash assets that ended in tears. Whether it was Beanie Babies or revenue-less dot coms, there have been plenty of times when once-coveted items collapsed in price.
To know things are frothy, you need look no further than New Zealand, where just a month ago a houseplant sold for $19,297 (USD). This “very rare white variegated Rhaphidophora Tetrasperma,” which sported a full nine leaves, was the subject of a heated bidding war. Is this Tulpenmanie revisited? As Mark Twain said, “history doesn’t repeat but it does rhyme.”
How does an investor keep from getting swept up in speculative nonsense, especially when they read about fantastic fortunes being temporarily made in everything from digital tokens to houseplants? By following one simple rule, advocated by Warren Buffett and other value investors: only purchase quality assets that can be valued based on their measurable free cash flow. The thing that distinguishes shares in great companies, valuable rental real estate, and plain bonds is that they all produce cash that can actually be counted. It sounds so simple, but it’s a difficult rule to follow—especially when the fear of missing out causes someone to deviate from this essential principle.
This is the fundamental difference between investment and speculation, and one that is forgotten at your own risk. Even quality assets with good cash flow sink in price when markets decline. Unlike tulip bulbs, however, they don’t just revert to dust. Said another way, they have real, quantifiable economic value. And that makes all the difference—in the end.