The Little Book of Value Investing

WHY INVEST GLOBALLY? Aren’t there plenty of opportunities in your own backyard? Perhaps. However, if you think of the universe of stocks as a grocery store as I do, why limit yourself to half the merchandise that exists in the world? While the United States contains approximately half the publicly traded companies in the world (out of a total pool of more than 20,000 stocks), if you expand your horizons to all the developed countries of the world, you can double your chances of finding cheap stocks. And these are not obscure risky little companies. When the top 20 corporations in the world are ranked by sales, 12 of them are headquartered in Europe and Asia. When measured by sales volume, the world’s largest oil company is based in the United Kingdom, and three of the five largest auto manufacturers are found in Germany and Japan:

Source: Forbes, Global 2000 Special Report, March 31, 2005.

Company	Sales ($ billions)	Country
Wal-Mart	285	United States
BP	285	United Kingdom
Royal Dutch/Shell	265	Netherlands
Exxon Mobile	263	United States
General Motors	193	United States
Daimler Chrysler	192	Germany
Ford Motor	170	United States
Toyota Motor	165	Japan
General Electric	152	United States
Chevron	142	United States
Total	131	France
Volkswagon	120	Germany
ConocoPhillips	118	United States
Allianz	112	Germany
Citigroup	108	United States
Nippon Tel	106	Japan
AXA	97	France
IBM	96	United States
AIG	95	United States
Siemens Group	93	Germany

Think of the companies that produce some of the products and services you run across every day: Nestlé, ING financial services, Honda, Toyota, Glaxo Smith Kline, Bayer, Sony, Samsung, Hyundai, Mitsubishi, Carnival Cruise Lines, Fuji Film, and Heineken Beer. All are large, well-known companies whose products we use or see nearly every day of our lives. To ignore global opportunities means not investing in many of the world’s largest and finest corporations.

Much of the current financial literature and the advice of high-priced consultants focuses on investing in foreign stocks to achieve global diversification. The idea seems to be that by investing outside our home base, we can protect ourselves when stock prices fall at home. With a much more global economy, however, most foreign markets tend to move in the same direction. A hiccup in New York impacts London, and today’s Tokyo news is required reading in Paris. The drastic sell-offs of the early 1970s, the stock market crash of 1987, and the bubble burst in 2000 were shared across the globe so diversification offered scant protection. Likewise, the rally off the lows of 2003 seems to have spread across the globe as well. The real reason to invest with a global focus is to double the number of potential value opportunities from which we can choose.

My initial exposure to expanding the principles of value investing globally came from friends and clients around the world whom I have met over the years. It was in discussions with these contacts that I became aware of some of the extreme value opportunities around the globe.

My first foray into international stocks came in the early 1980s. A former associate of Graham’s who was retired and living in Barbados told my longtime partner John Spears to look at the Japanese property and casualty insurance companies because they were selling for one-third of book value. Japan was on the rise in those days, and there were few cheap stocks listed on the Tokyo Stock Exchange. Finding Japanese insurance companies selling at one-third of book value was the value investor equivalent of waving a steak bone in front of Fido. But when John took a look, it appeared that the companies were all selling at stated book value. So John went back to Graham’s associate and told him what he had found. Ben’s friend told John the difference was that the Japanese insurance companies reported book value with their large investment portfolios carried at cost. With the huge run-up in stock prices in Japan, the value of the portfolios had tripled. This information was not widely known, but was filed with the Tokyo stock exchange (in Japanese, of course). So we found someone fluent in Japanese to research the insurers. Sure enough, with the security portfolios valued at market, the companies were selling at one-third of book value. We bought about eight insurance company stocks. Six months later, the regulators changed the reporting requirements to show the security portfolios at market. Once the market saw this, the stocks went up to their adjusted market value. Luck doesn’t hurt in the investment world!

My next foray into international markets occurred in the mid-1980s. In my travels, I noticed that European businesspeople were not all that different from those I knew in the United States. They got up each day and went to work looking to make a profit. I also noticed that Europe was not as oriented toward the stock market as investors in the United States, and this seemed to create bargain opportunities. Instead of being put off because they were not U.S. companies, I became intrigued. The comparison with U.S. companies highlighted how cheap some of the European stocks actually were. At about the time that U.S. consumer products companies like Carnation and General Foods were being acquired at 6 to 10 times pretax earnings, we found companies like Distillers Corporation in the United Kingdom selling at 4.5 times after-tax earnings. The only negative for the company was that it happened to be incorporated in the United Kingdom, which was in an economic morass in the early days of Margaret Thatcher’s prime ministership. Distillers was ultimately acquired less than a year later at a price twice its market price of 12 months earlier. We found many other mundane companies such as tobacco companies, insurance companies, insurance brokers, and banks, all at very cheap prices that represented quality value opportunities.

Naturally, my interest in taking a more global approach to investing was piqued. At that time it was not possible to take as disciplined an approach to European and Asian investing as I would normally prefer. In the United States, my partners and I had access to a database of all public companies and their SEC (Securities and Exchange Commission) filings with fairly comprehensive financial information that allowed us to quickly and easily uncover a diversified range of value opportunities. Outside the United States, no such database existed. At the time, we had a client who worked as an investment banker in London. He seemed to feel that no one was doing bottom up, stock-by-stock value investing in Europe. He kept asking us why we couldn’t apply the same value criteria outside the United States. Everyone else was pretty much doing the same thing, a top-down macroeconomic type of investing with little attention paid to what a particular company was worth. Our answer was always the same: We had no database that would allow us to quickly screen and sort opportunities from among 11,000 non-U. S. stocks. This situation began to change in the early 1990s. Databases began to appear covering different countries and regions. By piecing together these various databases, we could finally screen a sufficient number of companies to come up with a diversified list of candidates. The databases varied widely as to quality and depth but by piecing together the various systems, we established a method of screening non-U.S. stocks that we could then research and analyze. I called my old friend the banker, and he became our first international portfolio client.

Although global stock markets seem to move in tandem, there are exceptions, usually resulting from some regional economic problems. In 1998 when the Internet bubble began to inflate in the United States, Japanese and European stocks were much cheaper. The cheapest U.S. stocks sold at one times book value and eight times earnings. The cheapest European stocks sold at 80 percent of book value and six times earnings, while the cheapest Japanese companies were available at just one-half their asset value. With the collapse of Asian markets in 1998, there were a lot of bargain stocks in developed Asian countries, whereas there were relatively few in the United States. The reunification of Germany in the late 1980s was another example of a time when foreign stocks were much cheaper than their U.S. counterparts. The German treasury had to print a lot of West German marks to trade for relatively worthless East German marks. This caused interest rates to rise in Germany and across the rest of Western Europe. As rising interest rates are the stock market’s worst enemy, this created sell-offs in the European markets and value opportunities far in excess of what existed at the time in the U.S. markets.

In a world where many of us drive a Toyota or a Lexus, enjoy a cold Heineken or Corona with our sushi, or stop for a nice Johnny Walker and soda or Beefeater martini at happy hour; use Flonase for our allergies; have insurance or other financial products from AXA or Allianz; watch movies on a DVD player from Sony or Toshiba; and load Fuji film into our Canon Camera, it seems foolish to limit our investments to just one country. By using a global approach, you can double the potential opportunities to stock the shelves of your value investing store and also put yourself in a position to benefit when other markets and companies are cheaper than your home-based counterparts.