Archive for the ‘international investing’ Category

Sure, you should invest globally, but I’d stay away from stock picking if I were you

Sorry this was late. I was about to just not post and mark it up to being busy. But I’ve been able to keep up posting every business day so far, and think you guys deserve at least something to show that I am, in fact, working, right? For any of you non-investors out there, this might delve a little into the obscure, but I’ll try to keep it as basic as possible. Trust me, it concerns you, too. map-of-japan

It must be really hard to manage a mutual fund that invests in international markets. Imagine having all of the same concerns about analyzing companies that domestic fund managers do and lay on top of that dozens of different political realities – in one economy (Russia), the government might even decide to nationalize a company, making your investment worth nothing.

Another, maybe more confusing situation was brought to my attention yesterday in an interview with two fund managers from IVA Funds. IVA is a relatively new mutual fund shop brought to you by Chuck de Lardemelle and Charles de Vaulx (among others). They’re all value managers and earned their street cred while working for First Eagle, under renowned investor Jean Marie Eveillard. In fact, even though their IVA Worldwide fund is only six-and-a-half months old, Morningstar’s already given them a hearty endorsement. (I linked to the A shares, but they do have a load-waived share class).

I’m not about to endorse a fund that’s only been around for half a year (or put it down), but I can tell you that they were smart, interesting guys.

One of their more contrarian assertions was that Japan, despite having a price-to-earnings ratio that’s relatively high compared to the rest of the world (last I checked, it came in at around 14), is one of the most undervalued markets.

Their reasoning? Well for that, we need a little bit of a history lesson. Japan suffered its own asset price bubble in the mid-80s. It popped, of course, and Japan went through an extremely slow and painful deleveraging process to bring prices back to Earth. For a time, companies couldn’t borrow money.

As de Vaulx explains it, that fear of running out of money has trained companies to stockpile huge cash hoards “just in case”. You’d think that having an “emergency fund” as a company might be a good backstop in the way it is for an individual, but for investors, it’s meant that Japanese companies have a low return on equity and don’t increase shareholder profits. For a good summary of the problem, click here.

How does that make a good value? Well, because of all that cash on their books, the P/E of a Japanese company gets distorted. Imagine a company that costs $50 on the market and has earnings of $1 per share. That’s a P/E of 50 and is pretty bad, right? But what if it had $45 in cash per share on its balance sheet after taking out all debt. Now, the $50 per share doesn’t look so bad. That’s why a lot of investors look at a company’s “enterprise value” rather than the P/E. To calculate enterprise value, subtract the cash per share (or if they have debt, add the debt per share) to the company’s stock price before dividing by the earnings. In the preceding example, the company’s enterprise value-to-earnings ratio would be 5. (Note: This can work the other way too. If a company has more debt per share than cash per share, the enterprise value ratio would be higher than the P/E.)

Japanese companies have a lot of cash, and that’s why Chuck and Charles think they see great deals in that area of the world.

To me, what isn’t clear is the last step required to make those companies worth investing in. If they don’t ever return the cash to shareholders, isn’t it worthless? Imagine if Google decided it would never pay a dividend for as long as the company was in business and instead hoarded the money or paid it to employees. The stock price would (and should) be $0.

So it seems a bet on Japan is a bet that the culture of those companies changes or that investors force it to change. Otherwise, that cash is just one hell of an emergency fund.

I often say that most investors should let professionals do the investing or stick with an index fund that simply tracks the market. But given the cultural and political complications that come into play internationally, I think a novice would be crazy to try to pick foreign equities on his own. There’s just to much to wrap your head around.

– Joe Light