Most investors hold the majority of their portfolios in domestic stocks. This isn't a surprise, investing domestically is familiar, and feels 'safer' than investing abroad. For investors willing to explore the unfamiliar I believe there are advantages to geographically diversifying a portfolio.
Investing exhibits a strong locality bias. Investors are more likely to invest in a local company compared to a company located on the other side of the country. Investors are more likely to invest in a company in the same state rather than one in a different state. I've met investors who only invest in Pittsburgh companies. It's not uncommon to find a fund that specializes in a small local sector.
The world is a big place with many different types of people and just as many different types of securities. In a local market there might be 3-5-15 different companies to choose from, whereas worldwide there are over 60,000 public stocks. Unless an investor specifically wants to limit their strategy to a narrow geographic niche it's reasonable to assume that globally there would be many more potential investment opportunities.
The difficulty with investing abroad is the difficulty with anything abroad, it's different. I live in the United States and I've traveled to Canada a number of times. Canada and the US are extremely similar, they look the same, we speak (almost) the same, our cars are the same etc. But for all the similarities there are slight differences. When I visit Canada the differences are noticeable, they are slight, but noticeable. A related thought is that I'm always amazed at is how culturally united the US is. I can travel to the other side of the country and everyone speaks the same, they have the same stores, and I can navigate without any issues. Going from Pittsburgh to Salt Lake City is more similar than Pittsburgh to Toronto.
Many of the complaints I hear about foreign stocks could also be made about companies that are low information stocks. These are companies that are dark whose shareholders need to buy a share then contact management for further information.
There are two objections I commonly hear about foreign stocks and low information stocks. The first is that it's hard to get information, and the second is how do you know it's true?
The first step is finding stocks to research in a broader manner. I prefer to create wide screens focused on a single country then go through the screen results one by one. If a country is small enough I won't use a screen, I'll just look at each stock listed in the country. An example of a screen I might employ would be all stocks in Germany selling for 1.25x book value or less. I would then work through the list sequentially.
It's at this point that a little creativity needs to be employed. I prefer to read an annual report for companies that I invest in, but sometimes they're hard to come by. Most foreign exchanges have information on listed companies such as summary financial statements and a link to news postings. Some exchanges have full financials, or links to them. In other countries it's necessary to find the name of the securities regulator and look up companies through their website. Here's a little trick, Google the company on the domestic Google, you'll get better results. For example Googling "Precia" on Google.fr brings back much better results compared to the same search on Google.com.
Fortunately for me as an English speaker, and you as an English reader we have an advantage in the investing world. Many companies worldwide put their full reports in English, or English updates that provide enough context to muddle through the foreign language annual report. I've used translation sites with some success as well. I've found that Romance languages translate into English well, whereas Asian languages do not. English is a very popular language for business and most large companies accommodate this. Small companies in smaller markets usually don't publish reports in English, but sometimes they do. My experience has been the smaller the country the more likely it is for a company to publish reports in English.
The language and understanding barrier is a hard one for most investors to get over. I want to look at the issue differently. When investing domestically we read annual reports cover to cover because we can, and because we've been told that we need to know all of that information to make an informed decision.
I want to propose that not all of the information in an annual report is necessary to make a good investment decision. I'd go a step further and say the amount of information needed to make a decision to invest is directly proportional to the company's valuation. If my investment thesis is that a company will grow at 15% for the next three years then I need to have channel checks and a lot of supporting information before I feel comfortable with that decision. If a company is selling for 50% of their net cash and are profitable I just need to ensure I'm not walking into a trap. I prefer to not buy investments where the outcome of my investment hinges on fine print buried on page 178 of an annual report.
If a company's valuation is low enough, and I can adequately diversify then an investment decision is reduced to defining the thesis and getting enough information to confirm or deny it. When investing in any lower information stock I think it's worth keeping in mind that there will always be another cheap company. If there are any unresolved questions, or something that doesn't sit right you should move on without hesitation. As mentioned above, there are over 60,000 stocks in the world. If you are going to have a portfolio of 50 names it's likely you'll be able to find 50 stocks that fit your criteria perfectly if you're patient.
My first criteria for a foreign investment is a stable and solid balance sheet. This is because a strong balance sheet protects me against errors. If I can buy a company with a net cash position that is generating free cash flow I can afford to be patient and wait for my desired outcome. A larger gap between fair value and my purchase price gives me room for error. If I purchase a company at 30% of book value and it turns out it's only worth 60% instead of 100% I will still double my money. This is an important point, the larger the valuation gap the safer the investment. This is true as long as the company is operating in a business as usual manner. A company that was profitable for decades and then lost their biggest client isn't a business as usual investment.
The second criteria for a foreign investment is that it needs to be based on valuation, not a specific event. In the US it's possible to participate in special situations where the outcome of an event is binary and results in a gain or loss. Usually these situations require additional research and have the potential to be very profitable. I won't invest in situations like this in Europe, or abroad. I want to keep my investments simple. I am looking for average or above average companies at very low valuations.
One way that I keep myself safe with foreign or low information companies is by buying companies where the owners have a large ownership stake. Additionally I prefer companies that pay dividends, and especially companies whose owners pay themselves via dividends. Dividends are more common outside the US. It isn't hard to meet this criteria.
My process for investing overseas isn't any different from my process investing domestically. But I've found something interesting. Earlier this year I looked at my performance from domestic stocks compared to foreign stocks. I have done much better investing in non-US companies. I spent a lot of time thinking about this and I believe it can be attributed to the fact that I'm much more selective when investing abroad because I want to ensure a great margin of safety, but also because I'm trying to protect against things I might not know. In the US I feel more comfortable with companies I research and at times I've been known to take a flyer on a questionable net-net or something else because I feel like I have a good grasp of the situation. Sometimes these things work out, but sometimes they don't.
A post like this wouldn't be complete without a paragraph on fraud. My impression is that investors have a universal view of fraud. That view is that fraud doesn't happen in their own country, but it happens everywhere else. My own view is that there are fraudulent companies everywhere, nowhere is safe. Use common sense, if a company appears too good to be true it probably is. It's not worth spending time on fairy tale companies when there are tens of thousands of other companies to look through.
For more on how I manage my portfolio check out my Oddball Investing mini-course.
Investing exhibits a strong locality bias. Investors are more likely to invest in a local company compared to a company located on the other side of the country. Investors are more likely to invest in a company in the same state rather than one in a different state. I've met investors who only invest in Pittsburgh companies. It's not uncommon to find a fund that specializes in a small local sector.
The world is a big place with many different types of people and just as many different types of securities. In a local market there might be 3-5-15 different companies to choose from, whereas worldwide there are over 60,000 public stocks. Unless an investor specifically wants to limit their strategy to a narrow geographic niche it's reasonable to assume that globally there would be many more potential investment opportunities.
The difficulty with investing abroad is the difficulty with anything abroad, it's different. I live in the United States and I've traveled to Canada a number of times. Canada and the US are extremely similar, they look the same, we speak (almost) the same, our cars are the same etc. But for all the similarities there are slight differences. When I visit Canada the differences are noticeable, they are slight, but noticeable. A related thought is that I'm always amazed at is how culturally united the US is. I can travel to the other side of the country and everyone speaks the same, they have the same stores, and I can navigate without any issues. Going from Pittsburgh to Salt Lake City is more similar than Pittsburgh to Toronto.
Many of the complaints I hear about foreign stocks could also be made about companies that are low information stocks. These are companies that are dark whose shareholders need to buy a share then contact management for further information.
There are two objections I commonly hear about foreign stocks and low information stocks. The first is that it's hard to get information, and the second is how do you know it's true?
The first step is finding stocks to research in a broader manner. I prefer to create wide screens focused on a single country then go through the screen results one by one. If a country is small enough I won't use a screen, I'll just look at each stock listed in the country. An example of a screen I might employ would be all stocks in Germany selling for 1.25x book value or less. I would then work through the list sequentially.
It's at this point that a little creativity needs to be employed. I prefer to read an annual report for companies that I invest in, but sometimes they're hard to come by. Most foreign exchanges have information on listed companies such as summary financial statements and a link to news postings. Some exchanges have full financials, or links to them. In other countries it's necessary to find the name of the securities regulator and look up companies through their website. Here's a little trick, Google the company on the domestic Google, you'll get better results. For example Googling "Precia" on Google.fr brings back much better results compared to the same search on Google.com.
Fortunately for me as an English speaker, and you as an English reader we have an advantage in the investing world. Many companies worldwide put their full reports in English, or English updates that provide enough context to muddle through the foreign language annual report. I've used translation sites with some success as well. I've found that Romance languages translate into English well, whereas Asian languages do not. English is a very popular language for business and most large companies accommodate this. Small companies in smaller markets usually don't publish reports in English, but sometimes they do. My experience has been the smaller the country the more likely it is for a company to publish reports in English.
The language and understanding barrier is a hard one for most investors to get over. I want to look at the issue differently. When investing domestically we read annual reports cover to cover because we can, and because we've been told that we need to know all of that information to make an informed decision.
I want to propose that not all of the information in an annual report is necessary to make a good investment decision. I'd go a step further and say the amount of information needed to make a decision to invest is directly proportional to the company's valuation. If my investment thesis is that a company will grow at 15% for the next three years then I need to have channel checks and a lot of supporting information before I feel comfortable with that decision. If a company is selling for 50% of their net cash and are profitable I just need to ensure I'm not walking into a trap. I prefer to not buy investments where the outcome of my investment hinges on fine print buried on page 178 of an annual report.
If a company's valuation is low enough, and I can adequately diversify then an investment decision is reduced to defining the thesis and getting enough information to confirm or deny it. When investing in any lower information stock I think it's worth keeping in mind that there will always be another cheap company. If there are any unresolved questions, or something that doesn't sit right you should move on without hesitation. As mentioned above, there are over 60,000 stocks in the world. If you are going to have a portfolio of 50 names it's likely you'll be able to find 50 stocks that fit your criteria perfectly if you're patient.
My first criteria for a foreign investment is a stable and solid balance sheet. This is because a strong balance sheet protects me against errors. If I can buy a company with a net cash position that is generating free cash flow I can afford to be patient and wait for my desired outcome. A larger gap between fair value and my purchase price gives me room for error. If I purchase a company at 30% of book value and it turns out it's only worth 60% instead of 100% I will still double my money. This is an important point, the larger the valuation gap the safer the investment. This is true as long as the company is operating in a business as usual manner. A company that was profitable for decades and then lost their biggest client isn't a business as usual investment.
The second criteria for a foreign investment is that it needs to be based on valuation, not a specific event. In the US it's possible to participate in special situations where the outcome of an event is binary and results in a gain or loss. Usually these situations require additional research and have the potential to be very profitable. I won't invest in situations like this in Europe, or abroad. I want to keep my investments simple. I am looking for average or above average companies at very low valuations.
One way that I keep myself safe with foreign or low information companies is by buying companies where the owners have a large ownership stake. Additionally I prefer companies that pay dividends, and especially companies whose owners pay themselves via dividends. Dividends are more common outside the US. It isn't hard to meet this criteria.
My process for investing overseas isn't any different from my process investing domestically. But I've found something interesting. Earlier this year I looked at my performance from domestic stocks compared to foreign stocks. I have done much better investing in non-US companies. I spent a lot of time thinking about this and I believe it can be attributed to the fact that I'm much more selective when investing abroad because I want to ensure a great margin of safety, but also because I'm trying to protect against things I might not know. In the US I feel more comfortable with companies I research and at times I've been known to take a flyer on a questionable net-net or something else because I feel like I have a good grasp of the situation. Sometimes these things work out, but sometimes they don't.
A post like this wouldn't be complete without a paragraph on fraud. My impression is that investors have a universal view of fraud. That view is that fraud doesn't happen in their own country, but it happens everywhere else. My own view is that there are fraudulent companies everywhere, nowhere is safe. Use common sense, if a company appears too good to be true it probably is. It's not worth spending time on fairy tale companies when there are tens of thousands of other companies to look through.
For more on how I manage my portfolio check out my Oddball Investing mini-course.
Given the information handicap one would have with researching foreign stocks, I'd guess you would demand a larger margin of safety than for a domestic U.S. company (say 30-50% BV vs. 50-70%, or whatever). And wider diversification, which might imply smaller positions (as a percentage of your portfolio).
ReplyDeleteSmaller positions means relatively larger expense ratios to trade these, and commissions for international trading are steeper than U.S. trades. What do you recommend as an upper limit expense ratio for foreign trades?
Counter intuitively I have bigger foreign positions to minimize trading costs. But trading costs can be managed, there are a lot of cheap foreign brokers.
DeleteI do demand a larger margin of safety from foreign holdings.
If one is not able to find undervalued investments among 5000 businesses in US, it is hard to imagine that one would be able to find them if they could just go abroad and look at several thousand more.
ReplyDeleteIf you're just looking at relative valuation then your comment is true. But if an investor is looking for something specific it's often hard to find. Can you generate a list of net-nets trading at 50% of NCAV in the US? There are none that I know of, yet worldwide there are plenty.
DeleteI tried to comment on this before but it didn't go through. Anyway, I am curious how you performed with your foreign stocks, both absolutely and stacked up against the appropriate index and against the rest of your portfolio.
ReplyDelete