I am always amazed at how value investors tend to fixate on backwards looking metrics and conclude that a business is undervalued. Investing in a business is all about the future. When I invest, I always want the wind at my back. I know that I sometimes make mistakes and I want to be sure that the macro backdrop will bail me out of those mistakes without too much pain.
Usually, the macro backdrop has meant that I wanted to be in a growing business sector that was experiencing margin expansion and increased returns on capital. I wanted to know why there was a secular reason for this trend having occurred and I wanted to be confident that this trend would continue for a long period of time.
When I first started investing, I would repeatedly lose money trying to invest in things that seemed cheap. Look at regional bank stocks today. There are dozens of these that optically appear cheap. They trade at discounts to book value, they’re growing their businesses and not saddled with bad loans. Maybe if you chose well, you’ll make some money. Maybe a stock at .7 times book value will eventually appreciate to 1.5 times book value. That’s a healthy return. However, that’s not for me.
Despite rosy outlooks issued by brokerage houses, the banking sector is mired in bad loans. The US economy is shaky at best. Interest rates will remain low for an extended period of time which will hurt net interest margins. Finally, regulators are out for blood and it seems that smaller banks are going to be the losers because they cannot afford the lobbyists and extra compliance people that the larger banks can. Can you make money in banking? I’m sure you can find the cheap banks that have been ignored, but that’s too hard. In investing, you are not given extra credit for difficulty. I want to find the obvious investments. To do that, I want to make sure the wind is at my back. Even the best managed bank in the US is merely “king turd on crap island,” to quote a good friend.
In the past, I’d consider whole sectors of the economy to be toxic. I just didn’t want to bother finding the bottom in a declining business. Now I’m thinking that whole countries may be toxic to investors as well. There will always be interesting investments in every country, but what if the macro, tax, regulatory and geopolitical environments are so highly stacked against you that you do not want to try?
Look at the data above. The top group consists of highly leveraged nations with stagnant growth, unfunded liabilities, high taxes, unfavorable demographics and rapidly increasing debt burdens. In the near future, there will be a day of reckoning—I don’t know how it will all shake out, but it will be a tough time for investors. The bottom set of countries have young populations, low debt burdens and growing economies. Where do you want to invest?
I’ll admit the rule of law is questionable in some of these places. Many of them have their own unique issues to muddle through. For the longest time, that was why I avoided them. But compared to the issues that we now face in the Western World, maybe some of these emerging markets do not look as bad. Most importantly, these countries have growing economies and growth eventually creates premium valuations for assets. I’m not sure if these are the seven growing economies that I’d focus on, but I think it is time for all investors to broaden our horizons and look further overseas.
It would be one thing if you were adequately compensated for taking risks in the Western World. If assets were cheap, I’d find the best industries and take my chances on the best companies in those sectors. I’ve done that in some industries like asset management, mining and mining services. However, on most valuation metrics, Western Markets seems fairly valued at best. Many companies are overvalued. What’s the right price to pay for a slowly growing business experiencing margin compression? That’s the issue today in the Western World.
At the same time, you can look overseas at businesses that are growing 20% a year and end up paying 5 times earnings for that business. In many cases, you even get a 5% dividend to go along with it. I’m not saying this is all foolproof, but it is worth investigating further. For a decade, I’ve heard that this is going to be Asia’s century. Besides buying commodities, I’ve mostly ignored that advice. However, I’ve never disagreed with it. Two weeks ago, a good friend of mine, who happens to be a very successful Asia focused investor, invited me to go explore a few countries with him. I never pass up an opportunity to have an expert share his wisdom. I’ve rounded up a posse of other successful investors and on Sunday, we’re off to go visit Asia. We are landing in Beijing and from there; we will go where the opportunities will take us. Stay tuned—I will share whatever I learn.