Value Hunting Overseas

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Includes: ACWI, AMZN, CHKP, DPUKF, DPUKY, HESAF, HESAY, NVZMF, NVZMY, TCEHY, TCTZF, WMMVF, WMMVY, WMT
by: Steven Chen
Summary

Earlier this year, I warned about an at least sideways US market, citing Warren Buffett's favorite market indicator.

Some previously recommended foreign stocks have been doing relatively well so far this year.

US investors should keep a global perspective instead of missing out on the other part of the world.

Expensive US Market

In January, I wrote this article, warning about a possible downturn in the US stock market in light of the then all-time-high Warren Buffett Indicator (i.e., the Market-Cap-to-GDP ratio of 149% vs. the historical average of 75%). No matter whether you like the theory of this indicator or not, the US market has experienced high volatility and has come down almost 3% since then (see below).

Source: Yahoo Finance; data as of 5/27/2018.

As we speak, the overall US stock market should still be treated as significantly overvalued, given the current Warren Buffett Indicator of 142.5% (see below).

Source: GufuFocus; data as of 5/27/2018.

Value Hunting Overseas

Earlier this year, I encouraged investors to look into global diversification with some special highlights on Hermas International (OTCPK:HESAY, OTCPK:HESAF), Domino's Pizza UK (OTCPK:DPUKY, OTC:DPUKF) in the following articles:

This Is How Hermes Excites A Guy Like Me

Domino's Pizza U.K. Is Quietly Shaping Into The Next McDonald's

Both US-listed ADRs have performed relatively well YTD compared to S&P 500 (see below).

Source: Yahoo Finance; data as of 2018/5/27.

I believe that many of the US investors are still underweighting the overseas markets, thus missing out a tremendous opportunity in the long run. Citing the weight (see below) of the MSCI USA Index in the MSCI All Country World Index (ACWI), Oppenheimer Funds pointed out that "anything less than a 48% allocation to foreign stocks in equity portfolios represents an underweight position in a significantly outperforming asset class".

For those who lack international equity exposure, below you may find a couple of recommendations for foreign stocks based on my following filter:

  • Rising revenue for the past three years (indicating continuous expansion of business);
  • Rising operating income for the past three years;
  • Rising free cash flow for the past three years (indicating meaningful cash generation alongside business expansion);
  • Stable or rising earning-before-tax (EBT) margin for the past three years (indicating bottom-line improvement excluding taxation impacts);
  • Stable or rising asset turnover ratio for the past three years (indicating at least no decline in efficiency leverage assets piling up from free cash flow generation);

Check Point Software Technologies (CHKP)

Headquartered in Tel Aviv, Israel, Check Point is a multinational provider of software and combined hardware and software products for IT security.

The company increased revenues from 1,630 million USD in 2015 to 1,855 million in 2017, operating income from 840 million USD to 924 million, and free cash flow from 929 million to 1,081 million, with EBT margin steadily above 50% over the period. In the meantime, its asset turnover ratio improved from 0.33 to 0.35. According to a report from Markets and Markets, the cyber security market is estimated to grow to $232 billion (USD) by 2022, at a Compound Annual Growth Rate (CAGR) of around 10% from 2017 to 2022.

The stock is currently traded slightly cheaper than its historical average (see below) in terms of P/E, P/S, P/CF, but not P/B.

Source: Morningstar; data as of 5/27/2018.

Wal-Mart de Mexico (OTCQX:WMMVY, OTCPK:WMMVF)

Wal-Mart de Mexico, a subsidiary of Walmart Inc. (WMT), owns and operates self-service stores in Mexico and Central America, including 1,820 Bodega Aurrera discount stores, 270 Walmart hypermarkets, 94 Superama supermarkets, 162 Sam's Club membership self-service wholesale stores, and 10 Medimart pharmacies.

The company increased revenues from 475,911 million MXN in 2015 to 569,366 million in 2017, operating income from 32,828 million to 42,156 million, and free cash flow from 26,377 million to 49,135 million, with EBT margin improving from 6.92% to 7.6% and asset turnover from 1.94 to 1.95 over the period. Such performance has beaten those of most other players, including its parent company, in today's retail world disrupted by Amazon (AMZN).

The stock is currently traded slightly overvalued compared to its historical average (see below) in terms of P/E and P/B, undervalued in terms of P/CF and fairly-valued in terms of P/S.

Source: Morningstar; data as of 5/27/2018.

Tencent Holdings (OTCPK:TCEHY, OTCPK:TCTZF)

Tencent is most famous for its mobile-first social network app, WeChat, which dominates the mobile internet market in China. As one venture capitalist puts it, WeChat is there "at every point of your daily contact with the world, from morning until night."

For the past three years, the company has apparently experienced tremendous business growth - revenues (more than doubled) from 102,863 million CNY in 2015 to 237,760 million in 2017, operating income from 36,596 million to 70,447 million, and free cash flow (again, more than doubled) from 32,326 million to 74,136 million. Meanwhile, Tencent has improved its EBT margin from 35.21% to 37.1% and asset turnover from 0.43 to 0.5.

The company clearly benefits from its moat through the so-called network effect, a phenomenon where an additional user of a good or service improves the value of that product to others. This builds a strong barrier to entry for other social network players so that investors should expect its continuous high return on capital for the years to come.

The stock seems very expensive at the moment, considering its P/E of 44.1, P/S of 13.3. But I think the valuation is about fair for long-term investors, given Tencent's both high ROIC/ROE and high growth rate as well as its historical valuation metrics (see below).

Source: Morningstar; data as of 5/27/2018.

Novozymes (OTCPK:NVZMY, OTCPK:NVZMF)

Novozymes produces a wide range of industrial enzymes and microorganisms. Together with partners, the company turns to biology to unlock business opportunities across industries. For example, it creates microorganisms that help farmers achieve a better harvest and support sustainable agriculture and delivers biological innovation to producers of ethanol, bread, detergents, textiles and many other products.

The company increased revenues from 14,002 million DKK in 2015 to 14,531 million in 2017, operating income from 3,884 million to 4,113 million, and free cash flow from 2,308 million to 2,371 million, with EBT margin improving from 25.86% to 26.67% and asset turnover from 0.77 to 0.78 over the period.

Novozymes did not experience as exponential growth as Tencent, but it did maintain a truly amazing 10-year record of keeping up stably high returns on invested capital, equity, and assets (see below).

Source: Morningstar; data as of 5/27/2018.

The stock is currently traded slightly overvalued compared to its historical average (see below) in terms of P/B and P/S, and undervalued in terms of P/CF and P/E.

Source: Morningstar; data as of 5/27/2018.

Summary

As the US stock market continues to trade at near record-high valuations, I believe now is one of the worst times for US-based investors to neglect global diversification. Those with long-term investing horizons could look into names like Wal-Mart de Mexico, Novozymes, Tencent, Check Point, all of which enjoy growth momentums in terms of revenue, cash flow, margins, and efficiencies. Compared to their historical averages, these stocks seem to be fairly valued. Therefore, buying these quality businesses at the fair price could be your best bet to achieve long-term investment goal for an international equity portfolio.

Disclosure: I am/we are long TCEHY, NVZMY, CHKP, WMMVY, HESAY, DPUKY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.