It's a good idea to keep some international exposure in your stock portfolio. Doing so adds diversification and can open you up to some exciting investment opportunities. However, you don't necessarily need to buy the stocks of foreign companies.
In this episode of Industry Focus: Financials, host Michael Douglass and financials specialist Matt Frankel discuss how you can get international stock exposure with companies you already know.
A full transcript follows the video.
This video was recorded on May 14, 2018.
Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, May 14th, and we're kicking off our International Theme Week by talking about, well, international in financials.
Folks, Industry Focus is a U.S.-based podcast talking about the U.S. stock market, so we spend most of our time talking about, well, domestic companies. But there's a whole world of stocks out there, and no portfolio is truly diversified without international exposure. So, this week, we decided to change things up by focusing on international stories. Every host is interpreting this a little bit differently. The way we've chosen to interpret this on the Financials show, for the inaugural show of this theme week, is to talk about U.S. stocks with significant international exposure. Other folks will be talking about companies that are actually based in foreign countries. We like to take that motley approach to how we interpret the theme week.
We're going to start off with a general discussion on international investing, just introducing the topic, then we'll talk about some of those specific companies after the break. First off, then, let's talk about international investing and the different ways you can invest.
Matt Frankel: Sure. The most obvious way is to just buy a stock that is a company that's outside of the U.S. But that's not for everybody. We'll get into the reasons in a minute. In addition to that, if you just want to set it on autopilot, you can use an ETF or mutual fund to invest in foreign companies. Like Michael said, the other way is to invest in U.S. stocks, or stocks with substantial operations in the U.S. but that also have a lot of foreign exposure as well.
Douglass: Yeah. One of the key things to think about when considering how to invest your portfolio, the asset allocation piece of this -- like, how much do you put in international stocks -- is also thinking about the different risk types here. A company based in London is very different from a company that's based in, let's say, São Paulo. You have to think about the different types of risk. We'll get more into risk in a little bit.
But, one of the things when thinking about that asset allocation is also considering the different types of risk that you're taking on. Is it political risk? Is it geographic risk? Is it the fact that companies are highly correlated with certain commodity prices? That's a thing you have to think about particularly with international stocks, but really in general about your portfolio.
All of that being said, Matt, how do you tend to think about asset allocation to international companies, or, let's say, international exposure in general in your portfolio?
Frankel: It's hard to tell for sure. I like to keep it between 10-15% of my portfolio, international exposure. Having said that, it's really difficult to get an exact percentage. For example, I own about 30 different stocks. It's really, really tough to figure out the exact percentage of each one's revenue that comes from overseas and to constantly keep that between a 10-15% window. Having said that, that's kind of what I shoot for.
We'll go through a few in a second, but a lot of the stocks that I own in my portfolio have substantial operations overseas. And generally, doing the quick math in my head before this episode, I am within that 10-15% range. That's a pretty good range to shoot for to hedge against currency fluctuations, add a little element of diversification to your portfolio, and things like that.
Douglass: Yeah. And a lot of what I think matters in terms of thinking about this is your own circle of competence. If you have traveled to a lot of countries, perhaps you've done business in other countries, you'll have a better understanding of what the puts and takes are as you're thinking about how to allocate your portfolio there.
As well, just consider your own risk appetite, in general. If you think about it for a minute, let's say, an emerging economy. You'll see this in parts of Southeast Asia, sub-Saharan Africa. Those are going to be very volatile areas, probably. If you are OK with volatility, there may be an opportunity there, depending on what you know and how well you invest. But the flip side of that is, you may also see really enormous swings. That's just something you have to consult your own risk tolerance and your own willingness to accept potential losses before really figuring out where and how and how much to invest internationally.
Now, I've talked a lot about some of the drawbacks, and we'll get to those a bit more formally in a minute. But let's turn to the advantages of international investing. I think one of the key core ones is the other side of that volatility, which is fast-growing, exciting investments. There are real opportunities with countries that are growing their GDP at 5%, 7%, 10% annually. Here in the U.S., it's a good year if we get to 2%. So, you really have to consider what the opportunity might be for a well-placed company in a fast-growing economy.
Frankel: Right. There have been periods in the past 20 years when you could have owned a China ETF for a 10-year period and quadrupled your money. These are investments that can be growing faster. Even what we think of as boring companies like telecoms, in some of these developing nations, they can be growing at 10-15% a year. So, these are opportunities that you don't have domestically, just because of the maturity of our economy.
Douglass: Right. One of the other things to consider is, in general, diversification. When you think about your portfolio in general, think about correlation. How much are you tied to particular trends or particular commodity prices, as I mentioned earlier? Well, one of the things that a primarily domestic stock portfolio is highly correlated to is, well, U.S. economic performance. And, to some extent, the rest of the world is, too. But, there are opportunities to diversify your holdings to make sure that you have these opportunities to benefit when other countries are prospering in ways that the United States isn't. That's a really important thing to consider here.
Frankel: Yeah, it's kind of the same thought process as when you put all of your portfolio in bank stocks. We love bank stocks. We talk about them every Monday.
Douglass: [laughs] We sure do!
Frankel: But we're not going to put all of our money in them. The same kind of concept applies here. We love America, we think American business is going to do great over the next 50 or 100 years. But that doesn't mean you want to put all of your money into America's economy. If something like 2008 happens, a lot of the stock markets around the world did a lot better than ours did in 2008 because of, obviously, what happened to the U.S. banking system. That's another reason you don't want to be 100% in banks.
Douglass: [laughs] Right.
Frankel: But, my point is, when a bad situation happens, you don't want to be completely levered to that one country's economy. The same thing is true for other countries, as well. If there's, say, a U.K.-specific incident that happens, you don't want to be too levered to that market. It kind of balances out your geographic risk, by investing in foreign companies.
Douglass: Yes. And I would say, more broadly, when I think about stocks, I'm usually considering their geographic risk. If one company does all of its business in California or Virginia or South Carolina or wherever, that's, to some extent, a concern, because a change in the regulatory environment in that one state can have a really outsized impact, or a natural disaster, or who knows? In the same way, being levered all to one country, again, there's a bit more spread-out of risk because we have 50 states in United States, but there's still some of that risk.
One of the other things to consider with international stocks, it can be both an advantage or a disadvantage, depending, is currency headwinds or tailwinds. U.S.-based companies operate on the dollar. When they have significant international operations, depending on whether the dollar is weak or strong, that can be a benefit or a drawback to their reported earnings. Now, it's not something we really consider a lot in terms of looking at investments because, let's face it, if the underlying business is strong, then currency headwinds or tailwinds are just a thing that you notice. But it's certainly something that you need to be aware of before considering investing in international stocks.
With that, let's turn to some of the drawbacks. We've highlighted some of these already, but we'll go through and talk about them a little bit more. First one, obviously, political risk.
Frankel: Yeah. Not every country is as stable as the U.S. A lot of people think our political climate is kind of shaky. Go to one of these emerging nations and see how uncertain things are in emerging markets. Venezuela comes to mind as a really big example right now, with the hyperinflation going on there. Things like that. If a political regime is overthrown, that could have a huge effect on investments in that country. Hyperinflation is a big risk in a lot of these emerging nations that don't have currencies that are quite as stable as the U.S. dollar. In short, be aware that not every country is as developed as America, and that's why they call some of these emerging markets.
Douglass: Right. And, of course, we've already talked about volatility, so I'll skate by that one, but I just wanted to reemphasize it one more time. Volatility is definitely a bigger concern with emerging markets in particular, in part because the expectation is, if a country has been growing its GDP at, I'm making this up, 7% annually, then, well, if they report 5% annual growth for a year, that can really shake a lot of investor confidence. Now, that may not necessarily change your underlying thesis around the country and around the specific companies that you might be investing in in that country, but you just need to be aware that things are probably going to be more volatile because there's more expectation for growth built in -- just like when you invest in growth stocks in general.
The other thing to point out here is that there's limited information available on many foreign companies. Basically, there are different regulatory requirements country by country, and that can make a really big difference in terms of what story you learn about a company.
Frankel: Yeah. Not every country has the SEC looking out for investors. Not every company around the world is required to file a 10-Q every quarter. There's limited information available on companies, especially in the emerging markets. That makes them kind of tough to research and value properly, especially for people listening who are looking at some of the metrics and consider themselves value investors. It can be much more difficult to value companies from emerging markets especially, and even developed countries around the world that don't have the same regulatory requirements that we do here.
Douglass: Right. With that, we're going to turn and talk about five specific companies that are U.S.-based but have significant international exposure, right after the break.
Alright, so, we've talked a lot about international investing. Time to talk through some companies with significant international exposure. First one, Matt, one of your favorites and one that, we joked before the episode, you always look for an opportunity to bring up, TD Bank (NYSE:TD).
Frankel: It's just a great bank stock. Ignore the international exposure, it's still a great bank stock. TD, if you're not familiar, Toronto Dominion Bank is the official name. If you live on the East Coast, you've probably seen a TD Bank branch, but they're not throughout the United States yet, which is one of the big reasons I like the stock.
TD Bank is one of the biggest banks in Canada. It's the sixth-biggest bank in North America. They're based in Canada -- which brings up, out of the five stocks we're going to talk about, this is the only one that's not based in the U.S. Currency headwinds are more of a factor here. Specifically, I get paid dividends in Canadian dollars from TD Bank. So, as the Canadian dollar has weakened, it looks like my dividend is going down, but that's really not the case.
Anyway. TD Bank has a lot of room to grow in the United States, has a very nice revenue division between Canada and the U.S. They have some growth catalysts. Like I said, they're only in pretty much the East Coast right now, and they've done a great job of growing both organically and through acquisitions. They recently acquired Target's credit card portfolio, just to name a couple. Scottrade is the other one I was going to bring up. They just really have a long avenue for growth for such a big bank.
Douglass: Yeah. There's a lot of reasons to like TD Bank. And it's the only one on our list that's actually not a U.S.-based company. Let's turn to Aflac (NYSE:AFL).
Frankel: This is one that people in America, especially, are usually surprised to find out is not predominantly an American company. In fact, America is a small portion of Aflac's revenue. They're big in Japan. Aflac is actually the No. 1 health and cancer insurer in Japan. They're a big, big company over there. We know them for their accident insurance, short-term disability insurance, things like that. Aflac, great example of, if you want exposure to another developed market -- Japan, in this case. Aflac is a dividend aristocrat. They've paid dividends for over 30 years in a row. They have a very low payout ratio, really good business fundamentals, and like I said, really great developed market exposure.
Douglass: Yeah. That's one of the things here to really highlight, I think -- Japan being their big market. That turns on its head the thing that we usually tend to see across a lot of, not just financials but a lot of sectors, where the U.S. is the big market, and a lot of others are the second-biggest or the third-biggest.
Frankel: Just to name one other statistic I forgot to mention, one in four Japanese households is an Aflac customer.
Douglass: Wow, talk about market share. That's pretty impressive. Let's turn to Welltower (NYSE:WELL). This is ticker symbol WELL. Folks who have been watching the company for a long time know that it used to be HCN, but they've changed it now to WELL, for Welltower, I assume. This is a healthcare REIT that's really strongly diversified both in the United States and outside of it.
Frankel: Yeah. If you've been following them for a while, they changed their name to Welltower. Their official name was Health Care REIT. It tells the story, but that's kind of a boring name.
Douglass: [laughs] Right. Not the best headline, maybe.
Frankel: [laughs] No. If you're not familiar with them, they're, obviously, a healthcare REIT, but they invest mainly in senior-specific properties: senior housing, long-term care, assisted living, things like that. They operate primarily in the U.S., but they have a big presence in Canada and the U.K. As of this most recent quarter, they have about 150 Canadian properties and about 120 in the U.K. So, a pretty big chunk of their revenue comes from overseas. They're susceptible to currency headwinds a little bit because of it, but that's actually helped them out at points in the past. These are kind of their two big growth markets. The senior housing industry is not as evolved over there as it is here.
So, the general theme so far is, we like stocks whose foreign exposure is a really nice complement to their U.S. exposure. They can leverage their brand name over in foreign markets. It adds a new growth avenue where the market might be getting a little saturated here. Right now, for example, there's big oversupply worries in the senior housing market. Not the case in some of these foreign markets that Welltower invests in.
Douglass: Right. That's a good point. Matt and I are both ... I wouldn't call us really conservative investors, but I would say, maybe we're not quite as high on the yield curve as a lot of other people. We definitely tend toward businesses with heavy U.S. presences, even if it's maybe not their majority, just because this is a large, rich, attractive market.
Let's turn to another REIT -- actually, our next two are both REITs, as well. Perhaps that's not surprising, because there's a lot of geographic dispersion in real estate. Public Storage (NYSE:PSA), ticker symbol PSA. This is a self-storage REIT. Self-storage tends to be a really attractive business model, both because the relationships tend to be sticky -- that is, once you put your stuff in a storage container, you tend to keep it there more or less indefinitely, and they're able to do very small increases in price every year or two to continue to ramp up their net operating income. And, Public Storage has about a 92% occupancy rate. Most self-storage companies can break even at 40% or less. So, it's a pretty attractive business model.
Plus, it has a lot of exposure in non-U.S. markets. Specifically, Public Storage only owns one self-storage facility outside the U.S. It's in England. They have a 49% interest in Shurgard Europe, which has 222 self-storage facilities. So, they're able to leverage that with market share there in Europe. Any other thoughts on them, Matt?
Frankel: Yeah. This is another issue, like I was mentioning with Welltower, some of the businesses aren't as evolved overseas yet. In Public Storage's case, self-storage is a small, small business over in Europe still. I want to say, I read right before this episode, there are about 2,000 self-storage facilities total across Europe. Just to put that in perspective, Public Storage has more than that in the U.S. alone. So, it's still a very small market.
And Public Storage just recently got into the development side of the game. They've generally grown through acquisitions and they're really ramping up their development program. That opens up a lot of possibilities overseas, if they start to really develop the Shurgard brand over there.
Douglass: Right. It's definitely a potentially attractive company. It's kind of the behemoth in self-storage. As a result, their growth tends to be a little bit slower compared to some of the smaller folks like Extra Space Storage. They boosted revenue 2% year over year last quarter. Funds from operations per share, or FFO per share, which is the typical REIT number, was about 1.3% growth year over year. So, you do tend to get some of that lower growth, but they could also be in a bit of a growth trough, which, once they've built some of this development into their pipeline and are lapping through that, there might be some real opportunities for them. And, again, there's a lot of optionality internationally, so that's a really good thing for them.
Finally, let's talk about Prologis (NYSE:PLD), ticker symbol PLD. This one is an industrials RIET, primarily logistics centers. 70% of the net operating income is in the U.S. Only 55% of their square footage is. They have really heavy diversification across Europe, which is their next-largest market, Canada, Mexico, Brazil, and then a lot of Southeast Asia. The nice thing there is, sure, most of your investment in the company is based off these large, mature markets, but there's significant optionality in some of these other markets, which are commanding much lower rents, but long-term, as they continue to expand and demand increases and etc., there are a lot of opportunities for that company to grow.
Plus, the majority of their asset management and third-party transaction fees are from outside the U.S., 52% vs. 48%. Not a huge majority, but that means they're active in the disposition market there, and they're seeing opportunities, which, hopefully, they can then leverage that deep knowledge into building their square footage footprint in these outside-of-the-U.S. markets.
Frankel: Yeah. I always call Prologis the e-commerce play that nobody's talking about. Amazon's their biggest tenant, not surprisingly. The statistic that stands out to me the most about Prologis is that online or e-commerce sales requires three times the distribution center space of brick and mortar retailers. So, as we gradually transition to more and more e-commerce, it's a very positive catalyst for Prologis long-term. Like Michael said, most of their revenue is still domestic, but that could very easily change going forward. They're in 19 countries right now, and some of them have the potential to become very big markets for the company.
Douglass: Right. Now, it's worth noting here, Prologis is currently in the process of acquiring DCT Industrial, which would increase the percentage of their square footage that's in the United States. But, there's still plenty of optionality internationally. And frankly, you look at core business metrics, they boosted revenue 10% year over year last quarter. Their core funds from operations were up 27%. Guidance for the year is for core FFO to get to nearly $3 a share from $2.81 last year. So, a lot of reasons to like the company, despite the fact that it's already pretty darn big. That's one of the things that I like about both Prologis and Welltower. They're big, and really do have quite a bit of growth ramp potential, which means that you get the stability of a large company while also getting some of the potential benefits of a growth company. Again, you're never going to get the kind of growth that you'll get from some small-cap tech stock. But, hopefully, that optionality gives them a nice growth ramp to churn out significant growth and dividends long-term for shareholders.
Frankel: Yeah, definitely. These REITs tend to be low volatility but can surprise you with how much growth they have over the long-term. Public Storage, for example, has handily beaten the S&P over the past three decades. I think it's returned something like 5X the S&P's return over 30 years, and with much lower volatility, much more stable of a business, than some of these smaller companies that can produce comparable returns.
Douglass: Yes. Because of our episode last week about dividend yield traps, lest you think that means we don't like dividend-yielding stocks, Matt and I both love REITs, and we both love talking about REITs. Not all REITs. There are some ones that are really kind of terrible. But there are a lot of equity REITs that are really very attractive, and we both tend to invest, or at least tend to look pretty hard at REITs when we're investing.
Folks, that's it for this week's Financials show. Questions, comments, you can always reach us at email@example.com. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!