This article on International Value Investing for big returns was written by Thomas Niel. Thomas is a private investor, a financial blogger and an accountant in Washington DC. Creative Commons photo by Skeeze, edited by Broken Leg Investing.
“Money never sleeps, pal”
— Gordon Gekko, Wall Street
When moviegoers first heard that line on the big screen in 1987, market globalization was at its infancy. Today, with many more options than ever for international value investing, the first question on your mind should be, “Which markets are safe?”
Many of today’s emerging powers (China, India, Brazil) had GDPs that were a mere fraction of their current economic might. Investors looking for overseas exposure (outside of Western Europe and the great Anglosphere) had limited options and needed local connections to invest. Fast forward to 2018, and international value investing is just a click away for most retail investors.
It is easy to take for granted the relatively high levels of integrity and transparency offered by the US markets. While accounting scandals pop up from time to time, for the most part American financial filings paint an accurate picture of a company’s financial performance.
This becomes more of luxury when investing overseas. Let’s take a look at how we can stay safe and find profitable international value investing opportunities.
Developed International Markets
While most of the stocks trading in Canada, Western Europe, and established East Asian economies such as Japan are dependable, hunting for net net and deep value stocks in emerging markets has its share of jurisdictional risks.
The good news for deep value investors is that we are not chasing “global trends” or betting on the “next superpower” — we are just trying to gain a statistical edge by investing in the highest quality net net and deep value stocks!
Even better news is that adding investments in established and safe markets such as Canada, the United Kingdom, and Japan further deepens your pool of net net and deep value opportunities. American markets contain just a fraction of the buying opportunities available worldwide.
With the pool of available American net net stocks ever shrinking, it pays to consider net net and deep value opportunities in the international markets.
Despite Western Europe and East Asia having mature, financialized economies, the popularity of value investing in these countries has not risen to the level seen in America. Western Europe and Japan do not yet have scores of aspiring Ben Graham's screening small cap stocks for the strongest investing opportunities. In the highly competitive world of investing, finding your “edge” sometimes requires stepping out of your comfort zone, scouring overseas markets for the best buys.
Available Markets for International Value Investing
For investors in the West, some of the best platforms for international value investing include Interactive Brokers and Boom Monex.
With Interactive Brokers (IB), you can trade international equities in the following jurisdictions:
- North America: Canada, Mexico
- Europe: UK, Western Europe, select parts of Eastern Europe (Baltics, Poland)
- Asia/Pacific: Australia, Hong Kong, India (limited to non-residents of Indian origin, and only the National Stock Exchange is available), Japan, Singapore
Boom Monex (based in Hong Kong) offers investors more options for investing in Asia. Asian markets available on Boom Monex but not IB include
- South Korea
Key International Value Investing Markets to Consider
The following international value investing markets offer safety and transparency on par with what you can find in the United States. They are also a great way for individual investors to get their feet wet investing overseas.
Canada: True North, Safe and Cheap
Canada is one of the most accessible markets for American value investors to dip their toes into international value investing. While the majority of the stocks listed on the TSX, TSX Venture, and CSX exchanges are in the natural resources/basic materials space (an area we prefer to avoid here at Broken Leg Investing), you can find deep value Canadian stocks across all sectors.
Many Canadian listings also have American Depository Receipts (ADRs) that trade on the American markets. For liquidity purposes, it may be optimal to receive trading permissions from a major broker (such as IB) and buy directly on the Canadian exchange.
Canada is fast becoming a hunting ground for American deep value investors, but opportunities still exist to gain a statistical edge by investing in high-quality Canadian deep value and net net stocks.
United Kingdom: Deep Value, Old Boy
The United Kingdom is another safe choice for international value investing. With dependable financial reporting, low levels of fraud, and a government that encourages foreign investment, there is minimal jurisdictional risk from investing in UK-domiciled companies.
The UK is also another great starting point for American value investors looking to seize opportunities overseas. Attaining trading permission from Interactive Brokers to trade the LSE is a simple process. Being the mother country of the English language, understanding financial filings should not be an issue for American investors.
For an in-depth study of how net nets performed on the LSE, check out Testing Benjamin Graham's Net Current Asset Value Strategy in London.
According to the study, between 1981 and 2005, net net stocks generated a 19.7% annualized return, on par with the above-average returns net nets yielded in other developed markets.
Japan: Land of the Rising Net Nets
The Japanese stock market has a mixed reputation in the investing community — initially overvalued during the 1980s economic boom, when the bubble burst (and Japan entered its “lost decade”), stocks became cheaper and cheaper, with even established blue chip names falling into “deep value” territory.
The macro story of Japan (rising debt to GDP, a potential demographic crisis, and a byzantine corporate system that promotes complacency and “not rocking the boat”) keeps many investors away. As a result, there are scores of net net opportunities available for international value investors.
There are a few caveats:
- Language barrier: Japan is a well-regulated, reputable market, but English-language financials are not always readily available — not being fluent in Japanese can be a barrier in conducting due diligence on Japanese deep value opportunities. There is some professional equity research available online about Japanese stocks (such as Fisco’s Corporate Reports), but most small cap Japanese stocks do not have English-language financial filings.
- Lack of catalysts: Japanese companies are more conservative than their American counterparts, especially when it comes to strategic alternatives such as spin-offs or Mergers and Acquisitions (M&A) activity. Activist investors have a tough time gaining a toehold in Japanese companies, as it is common for Japanese companies to be in cross-ownership arrangements (Keiretsu system).
However, if you are investing mechanically, capitalizing on the statistical edge found by pursuing a net net/deep value investing strategy, Japan may offer your portfolio a treasure trove of opportunity.
Japan-focused investors such as Steven Towns have had tremendous success turning over rock gardens, digging deep for value stocks in the Land of the Rising Sun.
Investors who looked beyond Japan’s macro situation (something they couldn’t control) and focused on selecting the highest quality net nets (something they could control) still won during “the lost decade.” Between 1985 and 2007, while Japanese stocks returned just 5% annually, Japanese net-nets yielded a 20% compounded return — an excess of over 15%!
The success of investing in Japanese net net stocks further shows the advantages deep value investing has over more macro-focused investing philosophies.
Other International Markets to Consider
Outside of Canada, the UK, and Japan, there are several other markets providing safe opportunities for international value investing.
Australia: Australia offers the low fraud risk, reliable financial statements, and high respect for property rights usually associated with the Anglosphere countries. Australia may have fewer net nets than some of the other countries mentioned, but it definitely should be on your radar when screening for high-quality net net and deep value stocks.
Brazil: While the country has a few jurisdictional risks (culture of corruption, volatile economy due to dependence on commodities), Brazilian companies generally have reliable financial statements. There are a fair amount of small cap deep value and net-net stocks trading on the Brazilian exchange. Two challenges for investors may be the lack of English language financial statements, as well as the unavailability to trade the Brazilian exchange on Interactive Brokers.
Hong Kong: A mature economy similar to Japan, Hong Kong offers many options for international value investors. English-language financial reports are easily accessible. However, compared to the other countries listed, there are some jurisdictional risks. As we get closer to 2047 (when the People’s Republic of China completes its integration of the former British possession), Hong Kong’s reputation as a safe, reliable market likely will diminish. The Hong Kong market already includes many mainland China-based companies, which may be too risky for your international value investing strategy.
Mexico: For American investors who have at least a grade-school fluency in Spanish, Mexico may be a great opportunity to look for deep value. Mexico’s economy may have some of the risks we like to avoid (political corruption, volatile economy), Mexico has a much more developed industrial economy than Americans like to give it credit. The Mexican stock exchange is available to trade on Interactive Brokers, providing easy access to American investors. One caveat to Mexico is the small number of equity listings: there are about 150-200 stocks available to trade, and only a few of these may meet your criteria for deep value/net net stocks.
Singapore: Singapore offers investors similar benefits to Hong Kong (mature economy, English-language financials), with the added bonus of political stability and complete independence from the PRC. The Singaporean market typically has around 100 net nets at any given time, providing international value investors additional depth to their global pool of opportunities.
International Value Investing in Markets to Avoid When Screening for Deep Value
Interactive Brokers has some of the most extensive global investing offerings, but many emerging Asian markets are not available. Hong Kong-based broker Monex Boom offers investors more opportunities in Asia, including the ability to invest in Thailand, Indonesia, Malaysia, and the Philippines.
The lack of analyst coverage by the Western and developed Asian markets may offer you an opportunity to find diamonds in the rough, but it is important to consider the challenges that come from emerging markets:
- Fraud/Reliability of Financials Risk: Emerging market stocks (especially those from China) have a bad reputation among value investors. Even here at Broken Leg Investing, we exclude Chinese stocks when assessing deep value opportunities!
- Rule of Law/Property Rights: It is easy to take for granted the level of property rights investors have when investing in America or the greater Anglosphere. In countries that only a generation ago were command economies, the risk of nationalization remains.
- Red Tape/Restrictions on Foreign Investment: Foreign investment is a touchy subject for many emerging economies. For example, India historically limited the ability of foreign investors not of Indian origin to invest in Indian equities. Recently, the Qualified Foreign Investor (QFI) program has opened this market up, but major brokers such as IB currently do not provide access for QFI investors.
- Liquidity Risk: Emerging markets have not reached the sophistication and wide coverage of developed markets. While this provides more opportunities for net net and deep value stocks, the flip side is the illiquidity of such securities. For an individual investor, this may not be as great of an issue, but it is important to consider the relative ease of entering/exiting a position, as well as high bid/ask spreads that reduce the risk/return profile of an investment.
China: Not All That Glitters Is Deep Value
It is important to separate the macro story of China from the realities of investing in mainland China-based companies.
Many a newbie deep value investor stumbles over Chinese stocks. Chinese companies as a whole have the reputation of being second-to-none at providing inflated balance sheets, phantom earnings, and other book-cooking chicanery that make Bernie Madoff look like an amateur.
It doesn’t help that many Chinese stocks are easily accessible in the Western markets — many small cap Chinese companies enter reverse mergers with US, Canadian, or offshore (Cayman Islands, British Virgin Islands) entities in order to get a US or Canadian listing.
Because of these rampant risks, we here at Broken Leg Investing filter out Chinese companies when screening for opportunities. While we may miss a profitable investment or two, in the aggregate, this is a highly proactive method to preserve your capital and avoid flat-out frauds.
Net Net Hunting Overseas Offers Added Risks — But a Greater Pool of Opportunity
There are many risks and headwinds investors face when scouring the globe for net net and deep value stocks. Don’t let them discourage you from international value investing. As seen from the studies mentioned above, overseas markets offer historical returns on net nets similar to those seen in the United States. With American investors competing for the strongest deep value buys, international markets are the place to look when searching for the highest quality opportunities.
Emerging markets may contain some diamonds in the rough, but with the risks of financial fraud, unreliable financial statements, and the red tape often placed on foreign investment, it may be safer (and more rewarding) to stick to established stock markets when deciding to pursue international value investing.
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