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Many U.S. investors prefer to stick close to home when choosing stocks, and that bias may be owing to the wealth of information available on U.S. publicly traded stocks in Securities and Exchange Commission (SEC) filings and to the transparency provided by U.S. generally accepted accounting principles (GAAP). With the scary headlines about Europe's debt crisis dominating the news in the past few years and the recent decline of emerging markets, many people may have been skittish about investing overseas because of risks such as currency fluctuations and political upheaval (Brazil and Egypt are the most-recent examples).

Other concerns include the ability to rely on the accounting standards used by publicly traded companies outside the United States and knowing how to scrutinize a foreign company's finances with the same intensity as when analyzing U.S. stocks.

Investors can achieve international exposure by purchasing U.S. firms adept at selling in places such as China and Poland. As examples, Virginia-based AES (AES) supplies capital and engineering services to Latin American nations that need to boost their electric power, and Kentucky-based Yum! Brands (YUM) generates half its operating profit in emerging nations.

This was the point also mentioned by Nathan Parmelee, co-adviser of the Motley Fool's Champion Shares PRO and Share Advisor services in the U.K. "Most people are more inter-nationally invested than they realize," says Parmelee, who points out that U.S.-based Coca-Cola (KO) generates 50% of its sales outside of the United States. As a result, Parmelee recommends that investors have to "look at where profits and revenues are being generated, not just where the headquarters are located or where it has its main (stock exchange) listing."

Nevertheless, Parmelee estimates that 46% of the world's publicly traded companies are headquartered in the United States, so once investors are more comfortable with foreign investing, they may be ready to find investing opportunities among the other 54% of the world's stocks.

In a broad context about the global markets, Parmelee now believes that "investors need to start dollar cost averaging into emerging markets, if they're not already." In the past few years, the developed world has greatly outperformed emerging markets, Parmelee notes. "Of course, that makes the recent price trends in emerging markets look pretty ugly and unattractive, but historically when everybody is leaning one way it's the best time to start averaging in."

Why venture abroad? Investor Nathan Tobik, who has a blog called "Oddball Stocks," adds that "investing only domestically means that an investor misses out on more than half of the investment opportunities worldwide." Tobik's day job is in IT, but at night he scans the globe to search for value plays. He explains that Americans may know more about publicly traded foreign companies' products than they realize, such as cars made by Toyota (TM), food from Nestlé (OTCPK:NSRGY) and goods from relatively unknown companies such as Corticeira Amorim SGPS SA (wine corks from Portugal) and Installux SA (EPA:STAL), a small French company with a large amount of cash on its balance sheet.

Installux's founder owns most of the company's shares. Tobik, who was recently featured in a The Globe and Mail (Canada's national newspaper) article, explained that Installux, a small, thinly traded concern that produces aluminum profiles and accessories for the building finishing sector. The company is profitable, has a low price-to-earnings ratio (P/E) of 7.2 and trades at about 66% of its book value. The firm boasts of €21-million ($28.5-million) of cash on its balance sheet and little long-term debt. The cash represents nearly half of the firm's €48-million market capitalization. The company's cash is masking its good results, Tobik explained. The company has generated returns on equity (ex-cash) in the mid-high teens.

Thomas Shrager, a managing director at asset manager Tweedy, Browne, notes, "Investors should invest a portion of their portfolio in foreign companies because there are good companies outside of the United States." As of March 31, 2013, the largest holdings in Tweedy, Browne Global Value Fund (TBGVX) included two Swiss pharmaceuticals, Novartis (NVS) and Roche Holding (OTCQX:RHHBY), European consumer products companies such as Swiss food conglomerate Nestlé SA and Dutch beer company Heineken Holding NV (OTC:HINKY), along with French energy company Total SA (B15C557: Paris Stock Exchange).

More Investigation Is in Order

Finding those good companies, however, can take more work than investing in U.S. stocks. To start, one major difference for investors accustomed to analyzing U.S. publicly traded companies is that many international firms report their revenues and earnings only twice a year: a semester or half-year filing and the annual report. But investors can generally obtain additional background, such as company presentations on the corporate website and even on stock exchanges' websites, say Shrager and Tobik.

Tobik adds that almost all companies he has studied have their annual report available for download on their website. Although firms in smaller European countries will almost always have an English version available, ones in larger European countries - France, Germany, Italy - sometimes do, but not always. Tobik notes that a country's regulator often will have English filings available even if they're not listed on the company's website. One example is the Portuguese regulator CMVM.

Exchange websites also have a wealth of data, including links to company websites and summary financials from the previous few years, explains Tobik. If investors want to trade a French stock, they could search the Euronext Paris website, he explains; if they want to trade a Portuguese stock, the Euronext Lisbon.

The next task is becoming comfortable with a different accounting system, International Financial Reporting Standards (IFRS) - a set of accounting standards developed by the London-based International Accounting Standards Board (IASB) that's becoming the global standard for preparing public company financial statements. The IASB, an independent accounting standard-setting body, includes 16 members from multiple countries, including the United States.

The IASB began operations in 2001 when it succeeded the International Accounting Standards Committee. The board's funded by major accounting firms, private financial institutions and industrial companies, central and development banks, national funding regimes and other international and professional organizations.

More than 120 nations and reporting jurisdictions now permit or require IFRS for domestic-listed companies, according to a report by the American Institute of Certified Public Account ants titled "International Financial Reporting Standards (IFRS): An AICPA Back grounder." Since 2009, Brazil, Canada, Korea, Mexico and Russia have adopted IFRS, and almost half of the Fortune Global 500 companies now comply with IFRS, according to the IASB's 2011 annual report.

About 90 countries have fully conformed with IFRS as formulated by the IASB, and companies based in those countries include a statement acknowledging that in audit reports. The AICPA report says that the European Union requires companies incorporated in its member states and whose securities are listed on EU-regulated stock exchanges to prepare their consolidated financial statements in accordance with the international standards.

Toward a Global Standard

For now, U.S. companies continue to use U.S. GAAP accounting standards, considered to be the gold standard. Many experts believe that a certain level of quality will be lost with full acceptance of IFRS in the United States, though the SEC has been expressing its support for a core set of accounting standards for many years. This could serve as a framework for financial reporting in cross-border offerings.

In early 2010, the SEC issued a release that advocated a single set of high-quality globally accepted accounting standards because it would benefit U.S. investors. The commission also reiterated its continued encouragement for the convergence of U.S. GAAP and IFRS. It's unclear, however, when U.S. GAAP and IFRS will be merged in the United States.

National managing partner Sanford A. Cockrell III and national leadership partner-IFRS Nicholas S. Difazio of accounting firm Deloitte & Touche have written that "based on currently available information, mandatory adoption (of IFRS in the U.S.) is expected to be in 2015 or 2016 at the earliest."

How tough is it to understand a foreign company's financial statements if they're prepared according to IFRS accounting?

"For the most part, an investor who can tear apart a U.S balance sheet or income statement isn't going to have any problems understanding an IFRS statement," Tobik explains.

But he lists a few differences between the two accounting methods that could be vital when during a stock study.

For example, IFRS doesn't allow "last in, first out," or LIFO, accounting for inventory, while GAAP does allow it. At times, IFRS permits capitalization of research and development costs, while GAAP requires them to be expensed. IFRS also values items on a balance sheet at fair value, but GAAP will allow a company to use the cost method.

As a result, Tobik says that "a marketable security held by an Italian company would be marked to market, where a U.S. company might hold it at purchase cost."

Parmelee notes that the different accounting treatments that Tobik mentioned for IFRS and GAAP are correct, but "generally the differences between the two aren't more extreme than can be found between two domestic companies using GAAP."

For example, Parmelee points out that CVS Caremark (CVS) uses FIFO ("first in, first out") inventory accounting, while Walgreens (WAG) uses LIFO.

As a result, to accurately compare the two companies' gross margins and earnings, investors must make a couple of manual adjustments to the reported results. "So the differences between IFRS and GAAP are important, but the variation possible within GAAP probably doesn't get as much attention from investors as it should," Parmelee says.

Read the Fine Print

Tweedy, Browne's Shrager stresses that investors must read the footnotes carefully when examining the financial statements of companies using IFRS because that will help in comparisons with companies that use U.S. GAAP. For example, a construction company may use percentage of completion accounting, or it can recognize the revenue only upon completion of the project.

In cases such as this, it's important to analyze the accounting methodology used by a company carefully as both types of accounting are acceptable - U.S. GAAP or IFRS - but the numbers might look quite different, Shrager says.

Mark Eckman, a CPA who works for an aerospace company, provides this advice when examining a foreign company's financial statements: "First point is to find out what accounting they use, also known as reading the footnotes. Without that information, they have little idea what to do." The next question to ask is, "Do they have a credible auditor?"

Tobik also states that larger global companies contract the same auditors as U.S. companies: PwC, Ernst & Young and so on. But he cautions that "having a good auditor doesn't do much to protect against fraud." For example, many Chinese reverse-merger companies have used well-known auditors but have been blatant frauds.

As a result, Tobik, along with several other foreign investing experts, cautions that the best way for investors to discover possible fraud is to conduct the due diligence themselves. "If something seems too good to be true, it probably is," Tobik says.

"I would encourage investors to look at earnings quality with accrual checks, make sure that the cash flow lines up with reported earnings and do some commonsense checks," he adds.

For example, if a company is generating $3 million of sales per employee and the company's competitors have $300,000 of sales/employee, it's a red flag, Tobik warns.

Parmelee says examining a company's past capital allocation decisions can be another helpful way to evaluate a company and whether you can trust it to treat shareholders fairly. To do this analysis, he recommends checking to see whether the company "has made acquisitions, who the seller was, what price was paid and how they worked out." Generally speaking, Parmelee notes that "companies that have transparent dividend policies and communicate clearly with shareholders are also positive signs when evaluating any company."

What About China?

Most of the experts - such as Parmelee, Shrager and Tobik - advise against investing in Chinese stocks for many reasons.

For example, Tobik says, "I don't do any investing in China due to the large amount of fraud." He acknowledges that there appears to be some great growth opportunities for investors, "but the growth potential needs to be balanced with the fact that China is still communist and they have the ability to take control of a company if and when they want."

Tobik also points out that most foreign investors don't own shares in the underlying company. Instead, these investors own shares in a special-purpose investment company that has a contractual relationship with the Chinese company to distribute dividends, he explains.

Shrager adds, "We invest all over the world but stay away from China and Russia, where the political interference is too high and the accounting systems that some companies use may not describe fairly their operations."

Developed markets such as the U.K., Western Europe and Australia generally have legal systems and market standards similar to those in the United States, Parmelee says. Japanese companies also have transparent reports full of detailed information, but getting up-to-date news in English between filings can be challenging.

But he adds that "in the developing world, things aren't as transparent and corruption is more likely to be an issue." This is particularly true in China, where capital markets are less mature and the U.S.-listed options are primarily state-owned companies (SOEs) and reverse mergers.

Many U.S. investors prefer to stick close to home when choosing stocks, and that bias may be owing to the wealth of information available on U.S. publicly traded stocks in Securities and Exchange Commission (SEC) filings and to the transparency provided by U.S. generally accepted accounting principles (GAAP). With the scary headlines about Europe's debt crisis dominating the news in the past few years and the recent decline of emerging markets, many people may have been skittish about investing overseas because of risks such as currency fluctuations and political upheaval (Brazil and Egypt are the most-recent examples).

Other concerns include the ability to rely on the accounting standards used by publicly traded companies outside the United States and knowing how to scrutinize a foreign company's finances with the same intensity as when analyzing U.S. stocks.

Investors can achieve international exposure by purchasing U.S. firms adept at selling in places such as China and Poland. As examples, Virginia-based AES (AES) supplies capital and engineering services to Latin American nations that need to boost their electric power, and Kentucky-based Yum! Brands (YUM) generates half its operating profit in emerging nations.

This was the point also mentioned by Nathan Parmelee, co-adviser of the Motley Fool's Champion Shares PRO and Share Advisor services in the U.K. "Most people are more inter-nationally invested than they realize," says Parmelee, who points out that U.S.-based Coca-Cola (KO) generates more than 50% of its sales outside of the United States. As a result, Parmelee recommends that investors have to "look at where profits and revenues are being generated, not just where the headquarters are located or where it has its main (stock exchange) listing."

Nevertheless, Parmelee estimates that 46% of the world's publicly traded companies are headquartered in the United States (44% according to a 2012 Time article), so once investors are more comfortable with foreign investing, they may be ready to find investing opportunities among the other 54% of the world's stocks.

In a broad context about the global markets, Parmelee now believes that "investors need to start dollar cost averaging into emerging markets, if they're not already." In the past few years, the developed world has greatly outperformed emerging markets, Parmelee notes. "Of course, that makes the recent price trends in emerging markets look pretty ugly and unattractive, but historically when everybody is leaning one way it's the best time to start averaging in."

Why venture abroad? Investor Nathan Tobik, who has a blog called "Oddball Stocks," adds that "investing only domestically means that an investor misses out on more than half of the investment opportunities worldwide." Tobik's day job is in IT, but at night he scans the globe to search for value plays. He explains that Americans may know more about publicly traded foreign companies' products than they realize, such as cars made by Toyota (TM), food from Nestlé (OTCPK:NSRGY) and goods from relatively unknown companies such as Corticeira Amorim SGPS SA (wine corks from Portugal) and Installux SA (EPA:STAL), a small French company with a large amount of cash on its balance sheet.

Installux's founder owns most of the company's shares. Tobik, who was recently featured in a The Globe and Mail (Canada's national newspaper) article, explained that Installux, a small, thinly traded concern that produces aluminum profiles and accessories for the building finishing sector. The company is profitable, has a low price-to-earnings ratio (P/E) of 7.2 and trades at about 66% of its book value. The firm boasts of €21-million ($28.5-million) of cash on its balance sheet and little long-term debt. The cash represents nearly half of the firm's €48-million market capitalization. The company's cash is masking its good results, Tobik explained. The company has generated returns on equity (ex-cash) in the mid-high teens.

Thomas Shrager, a managing director at asset manager Tweedy, Browne, notes, "Investors should invest a portion of their portfolio in foreign companies because there are good companies outside of the United States." As of March 31, 2013, the largest holdings in Tweedy, Browne Global Value Fund (TBGVX) included two Swiss pharmaceuticals, Novartis (NVS) and Roche Holding (OTCQX:RHHBY), European consumer products companies such as Swiss food conglomerate Nestlé SA and Dutch beer company Heineken Holding NV (OTC:HINKY), along with French energy company Total SA (B15C557: Paris Stock Exchange).

More Investigation Is in Order

Finding those good companies, however, can take more work than investing in U.S. stocks. To start, one major difference for investors accustomed to analyzing U.S. publicly traded companies is that many international firms report their revenues and earnings only twice a year: a semester or half-year filing and the annual report. But investors can generally obtain additional background, such as company presentations on the corporate website and even on stock exchanges' websites, say Shrager and Tobik.

Tobik adds that almost all companies he has studied have their annual report available for download on their website. Although firms in smaller European countries will almost always have an English version available, ones in larger European countries - France, Germany, Italy - sometimes do, but not always. Tobik notes that a country's regulator often will have English filings available even if they're not listed on the company's website. One example is CMVM, the Portuguese regulator.

Exchange websites also have a wealth of data, including links to company websites and summary financials from the previous few years, explains Tobik. If investors want to trade a French stock, they could search the Euronext Paris website, he explains; if they want to trade shares of a Portuguese company, the Euronext Lisbon.

The next task is becoming comfortable with a different accounting system, International Financial Reporting Standards (IFRS) - a set of accounting standards developed by the London-based International Accounting Standards Board (IASB) that's becoming the global standard for preparing public company financial statements. The IASB, an independent accounting standard-setting body, includes 16 members from multiple countries, including the United States.

The IASB began operations in 2001 when it succeeded the International Accounting Standards Committee. The board's funded by major accounting firms, private financial institutions and industrial companies, central and development banks, national funding regimes and other international and professional organizations.

More than 120 nations and reporting jurisdictions now permit or require IFRS for domestic-listed companies, according to a report by the American Institute of Certified Public Account ants titled "International Financial Reporting Standards (IFRS): An AICPA Back grounder." Since 2009, Brazil, Canada, Korea, Mexico and Russia have adopted IFRS, and almost half of the Fortune Global 500 companies now comply with IFRS, according to the IASB's 2012 annual report.

About 90 countries have fully conformed with IFRS as formulated by the IASB, and companies based in those countries include a statement acknowledging that in audit reports. The AICPA report says that the European Union requires companies incorporated in its member states and whose securities are listed on EU-regulated stock exchanges to prepare their consolidated financial statements in accordance with the international standards.

Toward a Global Standard

For now, U.S. companies continue to use U.S. GAAP accounting standards, considered to be the gold standard. Many experts believe that a certain level of quality will be lost with full acceptance of IFRS in the United States, though the SEC has been expressing its support for a core set of accounting standards for many years. This could serve as a framework for financial reporting in cross-border offerings.

In early 2010, the SEC issued a release that advocated a single set of high-quality globally accepted accounting standards because it would benefit U.S. investors. The commission also reiterated its continued encouragement for the convergence of U.S. GAAP and IFRS. It's unclear, however, when U.S. GAAP and IFRS will be merged in the United States.

National managing partner Sanford A. Cockrell III and national leadership partner-IFRS Nicholas S. Difazio of accounting firm Deloitte & Touche has written that "based on currently available information, mandatory adoption (of IFRS in the U.S.) is expected to be in 2015 or 2016 at the earliest."

How tough is it to understand a foreign company's financial statements if they're prepared according to IFRS accounting?

"For the most part, an investor who can tear apart a U.S balance sheet or income statement isn't going to have any problems understanding an IFRS statement," Tobik explains.

But he lists a few differences between the two accounting methods that could be vital when during a stock study.

For example, IFRS doesn't allow "last in, first out," or LIFO, accounting for inventory, while GAAP does allow it. At times, IFRS permits capitalization of research and development costs, while GAAP requires them to be expensed. IFRS also values items on a balance sheet at fair value, but GAAP will allow a company to use the cost method.

As a result, Tobik says that "a marketable security held by an Italian company would be marked to market, where a U.S. company might hold it at purchase cost."

Parmelee notes that the different accounting treatments that Tobik mentioned for IFRS and GAAP are correct, but "generally the differences between the two aren't more extreme than can be found between two domestic companies using GAAP."

For example, Parmelee points out that CVS Caremark (CVS) uses FIFO ("first in, first out") inventory accounting, while Walgreens (WAG) uses LIFO.

As a result, to accurately compare the two companies' gross margins and earnings, investors must make a couple of manual adjustments to the reported results. "So the differences between IFRS and GAAP are important, but the variation possible within GAAP probably doesn't get as much attention from investors as it should," Parmelee says.

Read the Fine Print

Tweedy, Browne's Shrager stresses that investors must read the footnotes carefully when examining the financial statements of companies using IFRS because that will help in comparisons with companies that use U.S. GAAP. For example, a construction company may use percentage of completion accounting, or it can recognize the revenue only upon completion of the project.

In cases such as this, it's important to analyze the accounting methodology used by a company carefully as both types of accounting are acceptable - U.S. GAAP or IFRS - but the numbers might look quite different, Shrager says.

Mark Eckman, a CPA who works for an aerospace company, provides this advice when examining a foreign company's financial statements: "First point is to find out what accounting they use, also known as reading the footnotes. Without that information, they have little idea what to do." The next question to ask is, "Do they have a credible auditor?"

Tobik also states that larger global companies contract the same auditors as U.S. companies: PwC, Ernst & Young and so on. But he cautions that "having a good auditor doesn't do much to protect against fraud." For example, many Chinese reverse-merger companies have used well-known auditors but have been blatant frauds.

As a result, Tobik, along with several other foreign investing experts, cautions that the best way for investors to discover possible fraud is to conduct the due diligence themselves. "If something seems too good to be true, it probably is," Tobik says.

"I would encourage investors to look at earnings quality with accrual checks, make sure that the cash flow lines up with reported earnings and do some commonsense checks," he adds.

For example, if a company is generating $3 million of sales per employee and the company's competitors have $300,000 of sales/employee, it's a red flag, Tobik warns.

Parmelee says examining a company's past capital allocation decisions can be another helpful way to evaluate a company and whether you can trust it to treat shareholders fairly.

To do this analysis, he recommends checking to see whether the company "has made acquisitions, who the seller was, what price was paid and how they worked out." Generally speaking, Parmelee notes that "companies that have transparent dividend policies and communicate clearly with shareholders are also positive signs when evaluating any company."

What About China?

Most of the experts - such as Parmelee, Shrager and Tobik - advise against investing in Chinese stocks for many reasons.

For example, Tobik says, "I don't do any investing in China due to the large amount of fraud." He acknowledges that there appears to be some great growth opportunities for investors, "but the growth potential needs to be balanced with the fact that China is still communist and they have the ability to take control of a company if and when they want."

Tobik also points out that most foreign investors don't own shares in the underlying company. Instead, these investors own shares in a special-purpose investment company that has a contractual relationship with the Chinese company to distribute dividends, he explains.

Shrager adds, "We invest all over the world but stay away from China and Russia, where the political interference is too high and the accounting systems that some companies use may not describe fairly their operations."

Developed markets such as the U.K., Western Europe and Australia generally have legal systems and market standards similar to those in the United States, Parmelee says. Japanese companies also have transparent reports full of detailed information, but getting up-to-date news in English between filings can be challenging.

But he adds that "in the developing world, things aren't as transparent and corruption is more likely to be an issue." This is particularly true in China, where capital markets are less mature and the U.S.-listed options are primarily state-owned companies (SOEs) and reverse mergers.

Source: Global Investing: How To Research Foreign Companies To Find Opportunities