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Robert Abbott
Robert Abbott
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Christopher Browne: Finding Value Away From Home

Uncovering value in other countries, and how to manage currency risks

June 12, 2019 | About:

Christopher Browne, the author of “The Little Book of Value Investing,” argued that one of the challenges of investing abroad was, and is, different accounting standards. Yet, as he pointed out in chapter 15, there are also accounting differences at home: “Companies in the United States keep two sets of books, one for shareholder reporting and another for tax purposes.”

With that in mind, accounting standards in other countries should not be as a high a hill to climb. What’s more, in Europe, companies keep only one set of books.

And that, said the author, creates some “valuable anomalies” such as the one he found in Lindt & Sprungli (XSWX:LISN), a Swiss chocolate company. At the time he discovered it, the company was selling at a price-earnings ratio of 10.7, which seemed low for a company with a strong market position and history of successful acquisitions.

Apparently, the valuation was depressed because of high depreciation and amortization: 37.7% per year. That’s because its assets were being depreciated very quickly. He wrote, “The assets were being depreciated every 2.6 years, which seemed a little short especially the way the Swiss build things.”

Using the Swiss industry average, rather than Lindt & Sprungli’s more aggressive rate, cut the company’s depreciation rate in half, and that meant adding back 23.8 million Swiss francs ($23.9 million) to pretax earnings. After taxes, that brought down its price-earnings ratio (adjusted) to 7.5, “which was one of the lowest P/E ratios for a major consumer franchise in the world.”

Browne added, “As you can see, while it may be an aggravation to understand accounting differences, doing so often leads to incredible opportunities.” Through his research in Europe, he found many such anomalies. In almost all cases, it meant that companies were reporting lower earnings and asset values than they would with American accounting standards.

While he thought of research in European accounting differences as a treasure hunt, he considered working his way through American “accounting quirks” comparable to “navigating a minefield”.

The reason, he wrote, was “American companies are more likely to put their best face forward to their shareholders so they can justify management’s bonuses and increase the value of their stock options.” On the other hand, companies in Europe and Japan were more concerned with conserving cash so they tended to write off their assets more quickly. This, in turn, means stronger balance sheets.

Investing in non-American companies has become easier with their use of American depository receipts. At the time the book was being written (2005-06), some of the prominent companies using them were GlaxoSmithKline (NYSE:GSK), Toyota (NYSE:TM) and Nestle (XSWX:NESN)).

He concluded the chapter by noting, “Although you may have to put forth a bit more effort to understand the differences around the world, it is worth it. The global approach to value investing provides many more opportunities to invest your money.”

Browne began the next chapter, 16, with this subheading: “Currencies confuse even the experts.” When investors buy stocks quoted in foreign currencies, their gains or losses will be affected by currency exchange rates as well as the performance of the stocks themselves. Until the introduction of the euro currency, Europe had some 20 currencies, all which fluctuated against or with each other, “Trying to figure out what the Italian lira was going to do versus the Spanish paseta versus the U.S. dollar would have been a challenge for Einstein.”

How do investors cope with the added risk and complexity? By hedging their investments in foreign stocks. For example, if an investor buys 1,000 pounds ($1,268.60) worth of shares in a British company, several outcomes are possible:

  • The stock goes up, but the pound goes down, leaving an investor with a smaller gain or no gain at all.
  • The stock goes down, but the pound goes up, meaning that all or part of the loss on the stock will be covered by the increasing value of the pound.

Browne added that many permutations are possible and the whole issue can be confusing, making good decisions harder.

Prudent investors will eliminate the currency risk, which allows them to focus on the stock’s performance. The hedging process is relatively simple to understand and use:

  • The original investment was worth 1,000 pounds, so the investor sells a 1,000 pound currency forward contract.
  • The investor now owns two instruments, one long and one short, of equal value. The currency risk is fully neutralized.
  • When the investor sells the stock, they also close out the currency contract and get paid back in dollars.

Interestingly, Browne pointed out that long-term investors can ignore hedging and just hold their stocks. Over the course of 10 years or more, the investment returns work out to be about the same. Short-term fluctuations end up canceling each other out over time.

A word of caution: He warned against switching from a hedged to an unhedged position, based on an expectation of how currencies will fluctuate:

“Again, the Brandes study reaches the same conclusion. Those who attempt to divine currency movements have generally had poorer results than those of us who choose one method and stick with it. I have always taken the position that what I think I know how to do is analyze companies, not countries. I like to stay within my circle of competence.”

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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