A value-oriented investment strategy can work in countries all around the world because the factors that underpin it can be found in countries all around the world
Value investing enjoyed a good year round the world in 2016 but reports such as this one in the Financial Times betrayed a degree of surprise it might have done so in the emerging markets where, it suggested, people traditionally seek “fat returns from young, fast-growing companies in young, fast-growing countries”. Such thinking overlooks the fact value is universal because what underpins it – human behaviour – is universal.
People will, for example, overreact as a result of greed or fear and so buy or sell stocks at the wrong prices whether they live in Berlin or Beijing. They will extrapolate the future from the recent past and so misjudge the prospects of businesses and industries operating in Asia as much as in America. And neither the developed nor the emerging markets have a monopoly on company accounts that are designed to be tricky to analyse.
Not that scepticism about value’s effectiveness abroad is anything new. In late 1997, for example, Baupost Group founder Seth Klarman – one of The Value Perspective’s favourite thinkers – addressed investors’ concerns about applying value investing principles outside the US on the basis “foreign companies are not particularly shareholder-value oriented”.
“Of course,” Klarman pointed out, “Ben Graham invented value investing when the US was effectively a foreign country to value investing principles.” Later on in his letter to investors, he wrote: “I frequently hear the argument that the rules are different overseas: the accounting murky, the annual reports unreadable, the currencies sometimes unhedgeable.
“All of these points are fair, but, rather than being arguments to avoid foreign markets, they are instead arguments to embrace them. After all, as an investor you never have perfect information, and the biggest profits are always available – just as they have been in the US – when competition and information are scarce. The pay-off to fundamental analysis rises proportionately with the difficulty of performing it.”
Let’s use two concrete examples from the recent past to underline our point that value can be found anywhere in the world – in a moment, one from Russia but first one from China. In 2012, when Xi Jinping took over as the country’s president, his new administration instituted a crackdown on corporate corruption and one of the first industries to be affected were the Chinese spirits producers.
Chinese spirits producers
Regardless of the quality of the individual businesses, share prices fell across the sector until they reached levels that were very attractive for value investors. To be honest, you could have pretty much invested in any Chinese distiller in 2012 and done very well since but we will focus on one of the country’s oldest and best-known liquor brands, Kweichow Moutai.
For a point of western comparison, it is not unreasonable to pick out Diageo – the producer of brands such as Guinness, Johnny Walker and Smirnoff – which tends to trade on a price-earnings (P/E) ratio of between 20x and 30x. Yet, at its lowest point in 2013 – and regardless of the strength of its brand, its balance sheet and its cash position – Moutai was trading on a P/E ratio of 7.5x.
As it often does, the wider market had forgotten about all the fundamental attractions of the business and was instead focusing only on very recent history. Much like the tobacco sectors of the UK and the US at the start of the century, investors, analysts and market commentators were completely writing off the prospects – indeed the entire futures – of Moutai and its peers. Comments such as “the brand is dead” and “no one will drink this in the future as new generation’s trade off to western brands” were not unusual. Today it trades on a P/E ratio of 30x, similar to that of a Diageo brand, which is by no means a value stock.
Around the same time the wider market was shunning Moutai and the rest of China’s liquor industry, it had a similarly low opinion of Russia’s utilities sector. To be fair, there were some sound reasons for this – at the start of the century, following a series of power black-outs, Russia’s government had encouraged the country’s utilities businesses to overhaul their infrastructure and many overspent wildly.
Rumours of a tougher regulatory environment hardly improved matters and share prices in the sector fell by an average of two-fifths in 2013 alone. One company, Inter RAO – despite being well-placed for any tough new regulations, having a strong financial position and being on the verge of becoming very cash-generative – actually saw its share price fall by closer to two-thirds that year and traded as low as 0.17x on price-book (P/B) by the end of 2014.
Effectively, by this stage, you could have bought it for almost nothing – and those who stuck to their value principles and did so would have been well-rewarded within a couple of years. Russia has been one of the world’s best performing markets in both 2015 and 2016 and a prominent factor in this performance has been its utilities companies, not least Inter RAO which trades now days on a P/B of 0.73x.
Nor are we merely ‘cherry-picking’ examples to make our point. The following chart – which the Financial Times article also used – comes from the 2017 Credit Suisse Yearbook and illustrates work by London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton analysing which of 23 countries around the world have offered an annualised premium for value-oriented investors since 1975.
Source: Financial Times, https://www.ft.com/content/1a533914-08a9-11e7-97d1-5e720a26771b. Past performance is no indication of future performance and may not be repeated.
As you can see, most of the 23 countries ranked by the London Business School team do offer some sort of annualised value premium. Leading the way, as it happens, with 7.1 and 5.4 percentage points respectively, are Russia and China but among the countries offering a premium larger than the global average of 2.1 percentage points can be found representatives from all five continents.