Most value investors are bottom-up. Yes, our focus should be the fundamentals of the business, not the macro economic factors that are less predictable and less controllable. But how far up should we get? Should macro factors be totally ignored? If not, how much attention should we devote to macro factors such as foreign exchange rates?
Somehow the answer came to me when I was reviewing an article I wrote earlier this year, which discussed how long is long-term. Of course it depends on your holding period; the longer it is the less important macro factors are.
The last few years, extraordinary and unprecedented as they have been, offered good lessons in terms of thinking about the macro factors, especially foreign exchange. Let’s take a look at the 2015 currency impact on a few well-known companies:
Nestlé (NSRGY, Financial) - currency impact reduced sales by 7.4%.
IBM (IBM, Financial) - A strong dollar cut IBM’s earnings by $1 billion last year and revenue by about $7 billion.
Phillip Morris (PM, Financial) – During Q4 2015 alone, Philip Morris recorded a negative $1.1 billion revenue impact from foreign exchange swings.
These are on top of the horrific foreign exchange impacts of 2014, which most people thought could not get worse.
The problem isn’t just translation because the value of a currency does impact how consumers around the globe make decisions. Non-U.S products suddenly appear much cheaper. So construction companies buy Komatsu (KMTUY, Financial) equipment instead of Caterpillar (CAT, Financial) equipment. I can spend another article discussing these non-translation impacts but for the sake of this discussion, let’s stay with only the translation effect.
Now imagine you were a Nestle shareholder at the beginning of 2010 and you totally ignored the currency impact. Here is the result:
Nestle could have had at least 30 billion Swiss francs more in revenue and more than $4 billion in net income if there had been no foreign exchange impacts during these six years.
But if you were a Nestle shareholder at the beginning of 2004, here is what you would have had in terms of foreign exchange impact for the next few years:
Things looked much better back then, right? Boy, if only we could have only positive foreign exchange impacts.
In an interview with Consuela Mack, renowned value investor Tom Russo (Trades, Portfolio) mentioned an astounding fact: Even though his portfolio companies have been suffering from adverse foreign exchange impacts for the past few years, currency has actually had a 0.5% tailwind impact since the inception of Sempa Vic Partner. And that makes sense because with higher GDP growth and faster per capital income growth usually comes stronger currency. However, it’s not a linear upward line.
The implication from the above is if you invest in companies with a ton of international exposure and you only hold them for a few years, you need to take consider foreign exchange impacts in your thinking. Yes, it is less predictable, and yes, it involves a lot of learning and constant monitoring. But that’s the price you need to pay if you are not a real long term investor.
It seems to me that the prudent way to think about foreign exchange impact seems to be that one could either develop a framework that incorporates various macro factors that impact foreign exchange, or embrace a super long term investment horizon so that the macro factors are smoothed out over time. But to ignore macro factors altogether just because we are value investors seems inappropriate at best and perilous at worst.
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