When Appreciation Becomes the Investment Thesis
Part 3 of 4 | Separating the Story From the Economics
When asset prices rise faster than the underlying economics, what exactly are investors underwriting?
Professional sports franchises have historically demonstrated extraordinary appreciation. Their scarcity is undeniable, their global reach continues to expand, and their ability to generate revenue has evolved significantly.
Media rights, corporate sponsorships, premium experiences, sports betting partnerships, and international audiences have fundamentally changed the economics of professional sports.
Institutional capital has taken notice.
But as valuations climb, an important investment question emerges:
At what point does the expectation of future appreciation become more important than the underlying economics of the asset?
This question extends well beyond professional sports. It applies to private equity, commercial real estate, closely held businesses, and virtually any asset whose valuation depends heavily on future buyers.
When Transactions Become Valuation Benchmarks
Consider a hypothetical professional sports franchise valued at $6 billion.
An investor acquires a minority ownership interest in a transaction implying an $8 billion valuation. That transaction becomes a potential comparable for other franchises.
Another ownership group can now reference the $8 billion valuation when discussing its own franchise's market value. A subsequent transaction occurs at an implied valuation of $9 billion.
Suddenly, the market has another comparable. Nothing improper has occurred. These are transactions between willing buyers and sellers, each operating with their own investment objectives, expectations, and assumptions. However, something important has happened.
The transaction didn't simply reflect the valuation. It helped establish the next valuation.
There is an important qualification: minority ownership interests can carry different rights, restrictions, and liquidity characteristics. Consequently, an implied valuation from one transaction does not automatically establish the fair market value of an entire franchise.
Nevertheless, these transactions can influence market expectations and future negotiations.
And this is where understanding price discovery becomes particularly important.
The Difference Between Price Discovery and Economic Value
Public markets provide continuous price discovery. Millions of investors can evaluate information, express competing opinions, and transact throughout the trading day. Private markets operate differently. Transactions occur less frequently, ownership interests are less liquid, and the number of qualified buyers can be relatively small.
As a result, individual transactions can have a disproportionate influence on perceived valuations. But a higher transaction price does not necessarily mean the underlying asset has experienced an equivalent increase in earnings, cash flow, or intrinsic economic value.
That distinction is very important.
A franchise might command a premium because of its geographic market, media rights, brand strength, strategic importance, or scarcity. Those characteristics can have substantial economic value. However, investors must still determine how much of the purchase price is supported by the asset's anticipated financial performance and how much reflects expectations about future appreciation.
A compelling investment narrative and an attractive investment price are not necessarily the same thing.
When the Next Buyer Becomes Part of Your Investment Strategy
Consider two hypothetical investment theses.
Investment Thesis A:
"This asset produces attractive cash flow relative to the purchase price. Its underlying economics support our expected return, with potential appreciation providing additional upside."
Investment Thesis B:
"This asset generates relatively modest cash flow compared with its purchase price. However, its scarcity and anticipated future demand should allow us to sell it at a substantially higher valuation."
Neither thesis is inherently invalid. Scarce assets can appreciate over extended periods, and investors may reasonably accept lower current yields in exchange for anticipated long-term growth. However, the sources of expected returns are fundamentally different.
In the first scenario, investment performance is supported substantially by the economics of the underlying asset. In the second, a larger portion of the anticipated return depends on future market conditions and the willingness of another buyer to pay a premium.
The more an investment depends on future appreciation, the more important the assumptions about the next buyer become.
And those assumptions introduce additional considerations.
What Happens When Market Conditions Change?
Imagine purchasing an asset at a premium valuation based primarily on expectations of continued appreciation. Now consider what happens if interest rates increase, financing becomes more expensive, or institutional investors reduce their allocations to illiquid assets.
The asset itself might remain exceptional. Its brand may still be strong. Revenue may continue growing. Its competitive position may remain unchanged. Yet the universe of buyers willing or able to pay the anticipated future price could shrink. This creates an important distinction between business performance and investment performance.
An exceptional business does not automatically produce an exceptional investment return.
The price paid, the financing structure, the timing of cash flows, and the eventual exit valuation all influence the outcome. For investors in private markets, understanding these relationships is essential.
Bringing the Conversation Beyond Professional Sports
Professional sports franchises provide a particularly interesting illustration because their scarcity is visible and their valuations attract significant attention.
But the underlying principle applies across asset classes. A business owner considering an acquisition may justify a premium purchase price based on expectations of future industry consolidation.
A real estate investor may accept relatively low current income because comparable properties have experienced substantial appreciation. A private equity investor may anticipate that a future buyer will assign a higher valuation multiple to a growing business.
Each scenario may represent a legitimate investment opportunity. However, each also requires an examination of the assumptions connecting today's purchase price to tomorrow's expected return. The central question remains the same:
How much of the expected return is supported by the asset's underlying economics, and how much depends on future market participants assigning it a higher value?
Understanding that distinction can change how investors evaluate opportunities, structure transactions, and assess risk.
The Discipline of Separating the Story From the Economics
Strong investment narratives often contain legitimate economic opportunities.
Professional sports franchises are scarce. Certain businesses possess meaningful competitive advantages. Desirable real estate can have significant long-term value. But those characteristics alone cannot determine whether an investment makes financial sense at a particular price.
Investors must examine the relationship between the asset's fundamentals, the purchase price, anticipated cash flows, and the assumptions supporting future appreciation. When expected returns depend increasingly on selling an asset at a higher valuation, investors should recognize that they are underwriting more than the asset itself. They are also underwriting future market conditions and the behavior of the next buyer.
Price matters. Cash flow matters. And the assumptions connecting the two matter.
Understanding all three is fundamental to separating a compelling investment story from its underlying economics.
Coming Next | Part 4: Four Questions to Ask Before Buying the Story
In the final installment, we'll bring the series together and examine four questions investors, executives, and business owners can use to evaluate opportunities beyond the narrative.
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Arden Hill Partners is a DBA of Belpointe Asset Management. Investment advisory services are offered through Belpointe Asset Management, a registered investment adviser. This material is for informational purposes only and should not be construed as legal, tax, or investment advice. Business valuation and succession planning involve multiple disciplines, including legal and tax considerations. Clients should consult with their attorney and tax advisor regarding their specific situation.
This article is provided for educational purposes only and does not constitute personalized investment advice. All investments involve risk, and past performance does not guarantee future results. Hypothetical examples are illustrative and do not represent actual transactions.
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