If you plan to invest outside the U.S., where should you look? That was the question facing the investment managers at Tweedy Browne (Trades, Portfolio), and documented by Christopher Browne in his 2006 book, “The Little Book of Value Investing.”
Browne explained in chapter seven that Americans have traditionally had stock markets big enough to take care of their investing appetites, so they hadn't ventured abroad. In addition, countries outside the U.S. had their own accounting standards, some of which American investors found hard to understand. Browne wrote:
“However, I took a different view. I figured if Hans, a portfolio manager in Zurich, could learn U.S. Generally Accepted Accounting Principles (GAAP) I should be able to learn Swiss accounting protocols. Fortunately, understanding annual reports for companies around the world has gotten a lot easier today as most companies use standardized international accounting principles.”
As he began to research European and Asian annual reports, he came to understand them; “I found that European and Japanese accounting was not a minefield of deception—it was a treasure hunt.”
In Europe, he found many companies were hiding assets and understating their reported earnings to minimize their taxes. For example, Switzerland-based Roche Holding (XSWX:RO, Financial) liked to build reserves for contingent liabilities, and that had the effect of reducing reported earnings. Like some American banks, it was being conservative and financially astute. But investors had to do their due diligence to discover this fact. Further, he wrote:
“A few years later, Roche would reverse this questionable reserve. When an American company does this, the release of the reserve gets added back to earnings as it should. Not in Switzerland. Roche would merely add the reversed reserve to book value, net worth, without ever letting it show up as reported income. See what I mean by a treasure hunt?”
Another company that turned into a treasure hunt was Lindt & Sprungli (XSWX:LISN, Financial), a Swiss company that makes high-end chocolates. At the time, the company was highly profitable but selling for much less than its normal price, for two reasons. First, inflation had risen to 3.5%, which was very high for Switzerland and spooked investors. Second, Rudolph Sprungli had divorced and remarried—this time to a Scientologist. Swiss investors were very worried that his new wife would be appointed to Lindt’s board.
That explained, the Tweedy, Browne analysts next looked at the fundamentals. First, while Lindt was selling at 10 times earnings, it was also selling at only 3.5 times cash flow. The two measures did not seem consistent, and once again the analysts found something they had not previously known: Swiss companies can take as much or as little time as they like to write off their fixed assets. The company was writing off the cost of a new factory in just 26 months, and the explanation was that Sprungli was a very conservative manager.
Despite the differences, nuances in some cases, Browne and his colleagues continued to pursue opportunities outside their own borders. But as their explorations continued, they increasingly focused on countries in the developed world, countries with stable economies and reasonable governments. He added:
“The so-called emerging markets have a tendency to never quite emerge and remain unsafe and unstable places for investment. Although they can be the source of enormous speculative profits from time to time, they can also be the source of staggering, rapid losses. Look at Venezuela or Argentina. Investing in countries like this ignores the concept of having a margin of safety, and is a game I do not care to play.”
Note that Browne refers to margin of safety for the first time in this chapter. It helps us understand how Tweedy, Browne divided up the investing world. Without stable economies and reasonable governments, how can investors expect margin of safety to mean anything?
As noted in a previous chapter, Browne defined margin of safety as the difference between what an investor pays for shares and intrinsic value, what a knowledgeable buyer would pay for the whole company if it was sold in an auction. He has emphasized buying shares at a discount to what the knowledgeable buyer would pay. In particular, he favors Benjamin Graham’s rule of buying at two-thirds or less of intrinsic value.
In developed nations, and unlike emerging markets, Browne expected to find enough stability to ensure intrinsic value will not be influenced by unexpected (and often foolish) economic policies. For example, there appeared to be some wonderful bargains in Russia after the Soviet Union imploded, but insiders were manipulating financial markets and many Western speculators were burned badly.
Another example was Mexico in the early 1990s, when its stock market kept hitting new highs. As a result, a lot of non-Mexican money poured into those markets. Then, there were political assassinations and an abrupt currency devaluation. Markets crashed and any ideas of margin of safety were dashed. The same has happened in other Latin American countries, mostly in Venezuela. Thus, he concluded:
“Rather than tread the savannahs of the African interior, or the steppes of Siberia, or even the slopes of the Andes Mountains, more than sufficient profits are available if I mostly stick to stable economies with stable governments. This includes all of Western Europe, Japan, Canada, New Zealand, Australia, Singapore, and non-Chinese companies in Hong Kong. In these stable, mostly democratic, and capitalist nations, I continue to look for stocks that hold the same characteristics of value as do U.S. companies.”
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
Read more here:
- Christopher Browne: Low Book Value Deals & Foreign Bargains
- Christopher Browne: In Praise of Low-PE, Low-Expectation Stocks
- Christopher Browne: Enduring Principles of Value Investing
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