As pointed out in our latest study, the US stock market has done much worse for foreign investors than their American counterparts. This was caused by the dramatic dollar decline over the past decade. Will the trend of the dollar decline continue? We don’t want to predict that. But we know that the US budget deficit is getting worse; national debt is increasing at an alarming rate. Politicians in Washington care more about their next elections than anything else.
If you live in the US, you may not feel the pain of the dollar decline, yet. But you should be aware of the situation and protect yourself for the long term.
How to do this?
When we asked this question to Tom Gayner, the outstanding CIO of Markel Corp. (MKL), during the last value investors' conference, he said he invested in US companies with large international operations. This is also the answer by long term value investor Arnold van den Berg, as he said in our interview with him. So this is the one way of doing it:
Invest in US Companies with Large International Operations
How does it work?
When you invest in US companies that draw large percentages of its revenues abroad, the total revenue and earnings will benefit from the weak dollar. Considering Coca-Cola (KO), this is the operating income contribution by operating segment on a percentage basis:
|Year Ended December 31,||2010||2009||2008|
|Eurasia & Africa||11.6%||9.8%||9.9%|
This is what Coca-Cola said in their latest 10-K:
- In 2010, foreign currency exchange rates favorably impacted consolidated operating income by approximately 3 percent. The favorable impact of changes in foreign currency exchange rates was primarily due to a weaker U.S. dollar compared to most foreign currencies…
- In 2010, operating income was favorably impacted by fluctuations in foreign currency exchange rates by approximately 7 percent for Eurasia and Africa, 3 percent for Latin America, 8 percent for Pacific and 9 percent for Bottling Investments. Operating income was unfavorably impacted by fluctuations in foreign currency exchange rates by approximately 1 percent for Europe.
According to Coke, a weaker dollar has helped its earnings. For shareholders in the US, the company is earning more in dollar terms. The share price deserves to be higher if the earnings are higher.
Many US large cap companies are drawing large shares of their revenue and income from international operations. For instance, Johnson & Johnson (JNJ) had a total revenue of $61.6 billion in 2010. Out of the $61.6 billion, only $29.45 (48%) billion is from US operations.
Cigarette marker Philip Morris International (PM) is a spinoff from Altria (MO). The company draws all of its revenue from foreign operations. Out of the $67.7 billion revenue, $28 billion is from EU, $16 billion is from Eastern Europe, Middle East & Africa and $15 billion from Asia.
Walmart (WMT) has about 26% of its revenue from international operations, which are responsible for about 20% of the profit.
Therefore, US investors can protect themselves from dollar declines by investing in US companies that have large operations internationally.
Besides this, US investors can also invest in foreign companies that are traded in the US through ADRs. This is a smart investor Tom Russo’s favorite way of investing.
Invest in Foreign Companies That Are Traded in the US
You can also protect yourself from dollar declines by investing in foreign companies that are traded in the US. Many foreign companies that are traded in foreign exchanges are also traded in the US through ADRs. Investors can buy these shares just like they buy any US companies. The shares on the foreign exchanges and ADRs are usually exchangeable at the current currency exchange rates. Therefore a dollar decline will result in share price increases in US dollar even if the share prices in the foreign exchanges are unchanged.
When we asked Tom Russo why he likes foreign companies, he said:
“We have more than 70% of the fund in foreign companies. The reason is because we are long term investors, and we feel that foreign companies are usually family run, and they are long term minded. These companies usually have huge name recognition. They have the brands that have hundreds of years of history. This gives them huge competitive advantages. Their consumers are loyal to these brands.”
He said that his fund performance has benefited from the dollar decline by at least 2% a year over the past 26 years.
Let’s take a look at one of his largest holdings, Nestle. The food and beverage maker is traded in Swiss under the symbol of NESN. This is the price chart on Swiss exchange in Swiss France for the last 12 months.
Its ADR is traded under the symbol of NSRGY. This is the price of the ADR over the past 12 months.
Comparing those two charts, we can see that Nestle was down about 2% over the past 12 months on the Swiss exchange. But the ADR was up 28% in the past 12 months. The 30% difference in the performance of the same stock is caused by the devaluation of the US dollar against the Swiss Franc.
This is just an example how investing in foreign companies through ADR works. Similar examples can be found in many other companies from different countries. For an example, Toyota Motor Corp ADR (TM) is up 15% in the past 12 months. But in Tokyo exchange the stock is actually up only 2.55%. The difference is caused by the declining of the US dollar relative to the Japanese yen.
You are eligible for the same percentage yield of dividends through ADRs if the company pays dividends.
Predicting the short-term movements of currency exchange rates is as hard as predicting tomorrow’s stock prices. But over the long term, a country that grows faster and spends responsibly will see stronger currencies. Investing in US companies that have large operations internationally or investing in ADRs of foreign countries can help you to diversify your risk, protect you from dollar declines. Looking around, you may find a lot of foreign companies are quite worth investing.
Read Where to Find Value Ideas for International Stocks to find ideas for foreign countries. Or download our new GuruFolio report, where you will find a section for international stocks. For example, this is the link to Tom Russo’s GuruFolio report.
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