Famed investor Jim Rogers has spent a lifetime roaming the globe looking for out-of-the-way investments. He has famously said that he could determine whether he could make money in a country after having spent 20 minutes on the ground.
Following the announcement this past weekend that Berkshire Hathaway had invested $4 billion to gain control of Israeli cutting tool company Iscar, famed investor Warren Buffett said he expects that his company will be much more active overseas from here on out. The reasons are myriad, but one caught my eye -- Buffett said he wants to decrease Berkshire's exposure to the U.S. dollar by increasing its holdings in other countries.
The places in the world where one might find the best long-term value are not the same ones that the average investor might expect. Sure, China, India, Russia, and Brazil are obvious candidates, as are the oil-based economies of the world. But if large population, growth, and natural resources were the keys to prosperous countries, Pakistan and Nigeria would be among the world's wealthy countries, and size- and resource-impaired Singapore and Bermuda would not. Yet the opposite is true.
The Motley Fool just released its special international report, titled Around the World in 80 Minutes, which details some of our analysts' favorite stock ideas from beyond the shores of the United States. These companies all have that single element in common: They are based overseas. But like more than 1,000 other international firms, they've listed their shares on the U.S. stock exchanges. While we might want to assert that this is a benefit to U.S. shareholders, this is in no way their goals in listing themselves here. Rather, they list in the U.S. so that they might have better access to the U.S. capital markets. In other words, they do so for their own benefit.
Why are Chinese companies flooding the NYSE?
This is the cynic's view -- and it also happens to be true. Do you think that China Yuchai (NYSE: CYD ) , which owns 75% of a diesel engine market in China (ownership of which the local government recently tried to declare illegal) cares what you think, and thus decided to give you the opportunity to invest? No, no, heck no. (I can even prove that it doesn't: China Yuchai is owned 25% by Hong Leong Asia, which has a "golden share" that allows it to not even consider what outside investors think.) Even the good Chinese companies like PetroChina (NYSE: PTR ) and Ctrip.com (Nasdaq: CTRP ) make it clear in their filings that your votes don't really matter.
For better or worse, China has an economy that's simply too big and growing too quickly to ignore. For better, there will be many fortunes made in China. For worse, if you ever get the chance to talk with someone who has done accounting or auditing work in China, you'll understand that there is likely a high level of, uh, inexactitude in the numbers that these companies are reporting to their investors. If or when the Chinese economy swoons, this inexactitude might just matter a bit more, in ways that are pretty danged far from good. In fact, let me make this bold statement: Some time in the next decade or so, there is going to be a corporate scandal on a grand scale among some Chinese companies, and several of the ones now listed on the U.S. stock exchanges will be implicated. This will be costly to many people who buy into the "ascendant China" thesis.
Yes, China has growth and obvious potential in its 1 billion-plus population. Those are definite assets. But they're assets that everyone recognizes, and what's worse, they're Lucent (NYSE: LU ) circa 1999-type assets: ones that do a pretty good job of hiding a bunch of liabilities. In fact, most of the big foreign growth economies have corporate-governance and corruption issues that are quite shocking and debilitating. They may have growth and size, but they might not turn out to be the best risk-adjusted places to invest.
Think of China, India, Russia, Brazil, and the like to be the growth investments of the world. It is very likely that people who invest primarily in companies that operate in these markets will see an extremely wide distribution of returns: a few big winners alongside a larger number of hair-raising losers, with positive outcomes befuddled by investor overexuberance, massive boom-and-bust cycles, and structural flaws in these markets.
Big growth is good; small value is better
So now that I've thoroughly trashed the markets that people are most interested in (full disclosure -- I either own now, or have owned in the past, companies from each of the countries listed above), let's talk about what makes a "Hidden Gem" kind of market.
Interestingly enough, neither size nor natural-resource wealth are on the list. Actually, there is little correlation between size and/or natural resources and the economic success of a country. If there were, then Angola (minerals and oil), Ghana (gold and diamonds), and Argentina (spacious, fertile agricultural land) would be among the world's wealthiest countries, and Taiwan and Luxembourg would be indigent.
In fact, speaking particularly of oil, though the breathtaking wealth in the oil nations of Saudi Arabia, Kuwait, and Brunei show what happens when nearly inexhaustible resource wealth is accompanied by a small population, large oil revenues in countries that lack representative democracies have been, in general, more of a curse than a boon. Even taking the list of countries above, these are unfree societies that are hardly challenging Disneyland as "The Happiest Place on Earth" for their citizens. For more on this, read about the worries in the tiny African country of Sao Tome e Principe, which shares an offshore petroleum field with oil-producing basket case Nigeria. ChevronTexaco (NYSE: CVX ) and ExxonMobil (NYSE: XOM ) , among others, have just recently begun drilling in the field, and if projections are to be believed, nearly unimaginable wealth is about to pour into this tiny island nation. In advance of this windfall, there has already been an attempted coup -- not for ideological reasons, but rather because the military wanted to be able to control the money. You know, to dole it out for new schools and stuff. Stuff like a fleet of Ferraris parked in front of Swiss chalets.
Events in places like Nigeria and Venezuela provide a perfect contra-example for the types of countries that provide excellent investment potential. These are places with large populations, phenomenal physical assets, and abundant natural resources. Yet because of mismanagement, corruption, and greed, the percentage of these countries' populations that have benefited from these assets is minuscule. Those in charge have bled their countries dry. So if you're a foreign, minority shareholder in companies based in places with poor respect for the rule of law or property rights, just whom do you expect to protect your interests from those who are in charge?
Yeah, I couldn't come up with an answer, either. Ultimately, investors should focus not on the big, not on the resource-rich, but rather on the countries where the government and the populace have confidence in private enterprise. Obviously, it's nearly impossible to tell exactly what inputs are involved in determining economic success in any one country, but here are a few things to look out for.
1.Respect for rule of law, strong rights to appeal, and low levels of corruption. These are things that make investments in certain countries like Sweden and Finland appealing. Yes, these are high-tax environments, but they are extremely uncorrupt and fair. Nokia and Ericsson have thrived in these environments and have been dazzling investments for shareholders. The Philippines, on the other hand, is wealthy in resources, but it lacks a strong rule of law, and in the word of someone I know who grew up in the Philippines, "One government is as corrupt as the next." How many people, for want of a broken playing field, simply give up trying to get ahead in a baffling, stultifying bureaucratic miasma? The cost of corruption is manifold more than the simple amount of payola. (Put another way, those who engage in graft are reducing opportunities for their own children to succeed.)
2. Political stability and a government that makes up a small percentage of the local economy. There are a few prime examples here, but Bermuda and Hong Kong leap to mind as the greatest examples of human ingenuity making up for a lack of size or physical attributes. Bermuda has no income or corporate taxes, and Hong Kong's are paltry. These countries traded on their geographic locations near economic giants with higher tax burdens to become among the wealthiest countries in their respective regions. Neither got that way through big-government programs -- in fact, the existence of such would have had the opposite effect.
3. A stable currency. For most of the 20th century, the Mexican peso was the most stable currency in Latin America. It was, in fact, legal tender throughout the United States up until 1857. But as the Mexican government started spending wildly with money it didn't have, the peso collapsed, so where one peso was paripasu with the U.S. dollar for more than a century, now those old pesos are worth, effectively, nothing. Once again, a country needn't be big to have a currency that promotes local wealth -- it must simply have economic policies in place that support fiscal prudence and do not debase the currency -- one of the most insidious forms of theft ever conceived. In our new international report, we have two Mexican companies listed, and a real risk element is the fact that any peso-denominated cash in the bank is at risk of devaluation. (Though in the recent past the Mexican government has shown extraordinary improvement in its policies.) Why do you think that companies like CTC Chile (NYSE: CTC ) tend to pay such large dividends? Well, for one, what's the point of holding cash on the balance sheet when those assets in the past have shown a tendency to decrease substantially in worth? Should you view cash on the balance sheet for an international company in the same way that you might an American one? Well, that very much depends, now, doesn't it?
None of this is to say that there is an approved list of countries where you will make money, and a list of countries where you will not. After all, there are investor scandals in Luxembourg, and there are great companies based in places like Papua New Guinea. But the international investor has to take on a whole different set of risk and reward inputs to determine whether he or she has a reasonable chance at making money in the long term. But it is not enough to look for resources, or size, or population growth, or growth in GDP. The reality is that there are few resources more exploitable than foreign capital. Investing in another country means that you need to have an understanding about what the people to whom you are entrusting your money think about people like you. It may not be that you lose all of your investment, but you should at least have a reasonable chance of benefiting.
Bill Mann's investing career began in the former Soviet Union. He is the co-advisor of theMotley Fool Hidden Gemsnewsletter, where CTrip.com is a recommendation. For a limited time, you cansubscribeto Hidden Gems and get the international report, Around the World in 80 Minutes, for free! Bill owns shares of Berkshire Hathaway. The Fool has a disclosure policy.