Just a quick warning right off the bat: If you're one of those people who believes in jingoistic relabeling efforts, such as "freedom fries," you may want to skip this article. I'll just come right out and admit it. I'm one of those snooty college types who think just about everything's better "over there." When it comes to the things that make life interesting -- little things like food, wine, culture, architecture -- if we don't lack, we lag. If you've ever spent a 6 a.m. espresso break arguing international politics with a crew of dusty stonecutters on their way to put up new columns in the church in some microscopic Italian village, you might agree. Let's just say it feeds the spirit in a way that the rush of yuppie caffeine freaks at Starbucks (NASDAQ:SBUX) or the crabby "senior coffee!" crowd at McDonald's (NYSE:MCD) never can.
Of course, there's at least one thing we do a lot better here than anywhere else, and that's build businesses. For whatever they lack in soul, Starbucks and McDonald's have been a couple of the world's greatest investments, not to mention business models. Efficiency, service, and customer satisfaction -- those two set the bar. If you want to retire to that Italian village and argue with stonecutters, you'll get there sooner if you invest in America's finest.
For all its warts, the U.S. is still the place to do business. We've got reasonable regulations, reasonable freedom for enterprise, and we can all get a decent feel for the rules of the game. You think it's bad here? How about trusting your financial future to statements prepared according to the generally accepted accounting standards of Papua New Guinea? Unless you're a far different beast than I, those aren't words that inspire much confidence.
That said, it's not all tea and kippers on our shores. (Cough... Enron! Cough... ) Let's just say that accounting standards don't necessarily make for sound investing. And there are other reasons American investors should try to shovel some of their treasure onto foreign shores. The continual drag on the dollar is just one indication that foreign investors and governments have dwindling confidence in the "buy now, pay later" credo that guides our government and consumers. Where this may lead is anyone's guess, but Warren Buffett has made a well-known, multibillion-dollar bet against the greenback, so why not consider making one yourself?
Contrary to popular belief, there are decent businesses outside the U.S. Toyota (NYSE:TM) or Honda (NYSE:HMC), anyone? While giant, cyclical industries like these are definitely not on my watch list, they prove that nimble foreigners can not only succeed on their own turf but also challenge the biggest American firms and win. How'd you like to have put $1,000 on Toyota back in the '70s, back when everyone thought Detroit's carmakers would squash this puny upstart?
As I figure, it stands to reason that the best foreign firms should become the targets of investors as faith in America takes a slide. But even if that macro hypothesis doesn't pan out, I think it's hard to go wrong investing in companies with solid markets and good financials, no matter where they're located.
A few weeks back, in the process of putting together some screens to try to come up with companies that might make the cut as Motley Fool Hidden Gems: small, good cash flow, insider ownership, overlooked by most investors, I began to notice an increasing number of foreign firms. I decided to tweak the criteria to net only offshore enterprises and ended up using the following conditions.
- Market cap between $100 million and $2 billion. I'm looking for smaller companies for two reasons. They tend to have room to grow and are not yet dominated by large, institutional shareholders, meaning that when they do get bigger, the demand for their shares is likely to increase.
- Enterprise value-to-free cash flow below 15, or thereabouts. Given differences between GAAP in various countries, this measure isn't exact. But it's enough to give us ideas for further study.
- Insider ownership more than 5%. It's nice to see the managers on the same side as the rest of us.
- Net margins growing over the past year. I was looking for some evidence of improved operational efficiency despite a tough global economy. It's easy to do well when money's growing on trees. Companies that can get better in harsh conditions get a bigger vote of confidence from me.
- ADR or ADS shares available on major U.S. exchanges. Though there are some great foreign companies out there that trade only on the Pink Sheets (including one that made the cut for Stocks 2005) I wanted to restrict this search to more liquid issues, and regular ADR stocks fit the bill better than those on the pinkies. Unfortunately, this meant excluding some of my favorite businesses, such as Autogrill and H&M.
Just a word about the screen. While some of the folks on our very active Screening for Gems board use much more restrictive criteria, such as accelerating earnings or sales, I tend to cast the net a bit wider for a couple of reasons. First, narrower filters are likely to have an inordinate bias on foreign reporters because of variations in how the data are tabulated. But more important to my mind is that I'm willing to look at firms that haven't made the cut with their numbers. Quite frankly, I like learning about strange, obscure, and boring companies. Winners such as FARO Technologies (NASDAQ:FARO) and Middleby (NASDAQ:MIDD) -- which was a subject of discussion on the Fool Gems boards before it was an official pick, and long before its 200% run-up -- never made it through any of my screens. I'm only trying to suggest that the numbers don't always tell the whole story.
But they do provide a convenient starting point. After sifting upwards of 8,000 stocks with my foreigner screen, I was left with a couple dozen contenders. This week and the next, I'll share a few of the firms I find most interesting.
Brazil: more than poverty and thong jokes
Yes, we all had a good laugh when Homer Simpson's bikini bottom kept disappearing up his derriere while Lisa sought her pen pal at the "Filthy Angels" orphanage. Well, not the Brazilians. Some of them had a conniption. That's because the truth is that Brazil possesses the largest and most resilient economy in South America. It's survived shocks that have sent neighbors, like Argentina, reeling.
Sadia SA (NYSE:SDA) has weathered the storms even better. It's Brazil's largest poultry and pork producer and one of the biggest food concerns in the region. The vertically integrated enterprise sells its wares not just in Latin America but also across both big ponds to Europe, Asia, and the Middle East. Indeed, half its revenues are generated from overseas sales, a fact that ought to assuage those of you who have doubts about the Brazilian economy.
Products range from fresh to frozen, ready-to-eat meals, and a diet line. The Sadia brand is the best known in Brazil and is ranked in the top five for trustworthiness. The stock is the most actively traded in the country. Hidden? Not if you live down there, but up here, there's not exactly a wealth of coverage. (That doesn't mean you can't get a wealth of information. The investor section of the website at www.sadia.com offers better resources than you find in the IR section for American companies.)
Dig in a little, and you'll find the following interesting tidbits: a 30% return on equity over the past 12 months, healthy balance sheets, and $86 million in owner earnings -- a metric favored by Tom Gardner in his Motley Fool Hidden Gems newsletter -- for the first three quarters of the year. This is pretty impressive for a firm with a market cap of $1.3 billion and an enterprise value of $1.5 billion.
That should be enough to keep you from worrying too much about the slowed growth in net earnings over the past year (only a 6.7% uptick). Sales have been better: Net revenues are up 24% for the first three quarters of 2004. Net margins fell from 7.8% to 6.7% because of falling prices -- but they remain at a level that American counterparts only dream about.
Make no mistake, the food business is tricky and prone to big swings because of fluctuating commodity prices. Still, did I mention that the firm trades at a P/E ratio of eight? Sadia has the look of a steady, long-term winner, and as a bonus, there's a very respectable 4% dividend yield (I wonder whether the folks over at Income Investor are paying attention). It's definitely worth a look.
Italy through dark lenses
Even the most ardent fan of "freedom fries" should know enough to defer to foreign tastes when it comes to fashion. Even the wizened old lady who swabs out the baptismal fonts at Santa Maria de las Areas arrives to work in stylish togs and shades, which is why De Rigo looks like such an interesting investment idea. De Rigo is, simply put, a family-run eyeglass company with a market cap of $330 million and annual sales twice that. The firm designs several lines for its own use, as well as in partnership with outside firms. It also operates retail eyeglass stores in the U.K., Spain, and Portugal.
You may think you've never heard of De Rigo, but its sunglasses and ophthalmologic lines include partnerships with some of Europe's best-known fashion houses, including Escada, Fendi, Givenchy, La Perla, and Italy's oldest brand, Lozza. Thankfully, it seems to have moved beyond its odd fixation on names drawn from early-'80s English pop stars (though signature lines include "Police" and "Sting"). Current high-profile hawkers include British footballer and scruffy dreamboat David Beckham along with the continent's most famous race car pilot, Michael Schumacher.
Recent financial results have turned investors' heads, moving shares up a good 60% over the past year. Here's why: For the first half of the year, adjusted for U.S. GAAP, net income was up 35% over the same period last year, to euro 0.35 per share. The results were driven in part by major debt paydowns, resulting in significant decreases in interest expense.
But margins have also improved; 1.6% at the gross level and $1.3% for operating margins. Looking at the cash-flow statement, there's a 38% improvement in cash from operations over last year's result, with nearly $37 million booked so far. Even when you factor in the heavier capital expenditures this year ($9.5 million), free cash flow comes in 22% ahead of last year's first six months. Use last year's figure to extrapolate a run rate of $60 million for this year, and you're looking at a firm that still only trades at just over five times free cash flow. (Makes the P/E of 9 look pricey by comparison, eh?)
Best of all, De Rigo seems to know what to do with that excess cash. The firm has recently repurchased more than 5% of its shares at an average price of $6.30 per share and continues to do so.
The bottom lineNothing's certain in investing, but I am certain that a virtual grand tour can help sharpen your stock-picking skills. Even if you don't find anything you want to take home for your portfolio, you'll get a wider appreciation for what makes markets tick, and that will yield dividends down the road.
I'll share a couple more of these foreign finds next week; in the meantime, consider joining fellow Fools in hashing over other hidden treasures. You get 30 days for free to chat and check out previous picks.
For related Foolishness:
- Owner earnings? What the? Learn about this, and five more signs Tom Gardner looks for in winning stocks.
- Don't make the mistake of waiting forever to buy what you like.
- Check out the Fool's resources for those interested in international investing.
Seth Jayson enjoys small coffee, berets, unintelligible poetry, and very thin cigarettes -- all at once, if he can get 'em. At the time of publication, he had positions in FARO Technologies but no other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.
