Warren Buffett (Trades, Portfolio) has historically tended to stay away from overseas assets because he does not understand the rules and regulations that govern different countries' markets. However, that does not mean that he has completely avoided investing in foreign equities.
Buffett invests in China
One of Buffett's overseas investments was PetroChina (PTR, Financial). According to the Oracle of Omaha's comments, he bought this stock in the early 2000s. At the 2005 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting of shareholders, he declared that this was the first Chinese stock the conglomerate had ever acquired. It deployed around $400 million into the opportunity, making it a significant owner of the business at the time.
Based on his comments from 2005, Buffett had made a relatively simple calculation. He could see this company was earning $12 billion a year and produced 3% of the world's oil. The Oracle also noted:
"In the annual report, they say something which very, very few companies do say, but which I think is actually fairly important. They say they will pay out about 45% of the amount they earn."
He went on to add:
"So, if you can buy it at three-times earnings, what turned out to be three times earnings, and you get 45%... you're getting a 15% cash yield on your investment."
The margin of safety
This is a classic "heads I win tails I don't lose much" style investment. PetroChina was really cheap, and this valuation made up for some of the uncertainty Buffett would have encountered buying a foreign company.
This is Benjamin Graham's margin of safety in action. Buffett bought the stock at a dirt-cheap valuation, which leaves plenty of room for mistakes. Even if he thought the business was worth nine times earnings and was off by 50%, that would still be a 50% gain on the purchase price, excluding any income received.
And even if the stock didn't budge, if it were paying out 15% a year in dividends, any investor who bought PetroChina in the early 2000s would have done very well indeed.
In his book, "Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor," Seth Klarman (Trades, Portfolio) noted:
"A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world."
I couldn't think of a better way to sum up Buffett's trade. He might not have understood all of the intricacies of China's financial and political system at the time, but the margin of safety available on the shares was so substantial, it sufficiently compensated him and Berkshire's shareholders for the uncertainty.
This is something investors might want to keep in mind when investing overseas or in sectors or industries they are not particularly familiar with. Having a substantial margin of safety can compensate for lack of knowledge, although it should never be used as a substitute. Additional research is the easiest way to reduce risk.
Still, even if you have done your research, you can not factor in unknown unknowns. That is where the margin of safety really comes into its own.
