We spend most of our time discussing stocks from a bottom-up perspective. But sometimes the environment for business becomes more important than the business itself. When governments intervene between willing trading partners or property rights are not protected, the assumptions that underlying bottom-up investing no longer apply. For this reason, even bottom-up investors must be cognizant of the business environment into which they are considering investing.
For those who disagree, consider Venezuela, which is run by an administration that abhors capitalism. Nevertheless, many American businesses still have significant operations there. Undoubtedly, some of these businesses are cheap enough to pique the interest of the value investor. But value investors should stay away.
The country has been on a nationalization rampage, and no business is safe. Recently, the country's leader Hugo Chavez announced that it would be taking over the Venezuelan operations of Owens-Illinois (OI), the glass container manufacturer.
While the company had no advance knowledge of its nationalization, it could hardly come as a surprise. As we've discussed on this site before, investors in Venezuela should be very careful. Yet the company announced that "we were surprised to learn of this decision and we are prepared to work with government officials to better understand the situation." What's to understand? Venezuela is not a free country.
Bottom-up investing works and it works well. But it only works because in most environments with which we are familiar, companies are free to buy, sell and allocate their resources towards their most productive uses. Investors must not take this for granted; where this paradigm does not exist (either by geography, industry or otherwise), investors should be wary of using methods that rely on its presence.