By Conrad de Aenlle
LONG BEACH, Calif, Dec 2 (Reuters) - With U.S. stock markets hitting multi-year highs, investors are searching for bargains beyond America’s borders, where markets have underperformed for years.
MSCI indexes for Japan, Germany, France and Spain, for instance, trade at 14 times earnings, compared with 15 for the Standard & Poor’s 500; Britain is cheaper, at 13 times earnings, and MSCI’s broad-based index of emerging markets is cheaper still, with a price-earnings ratio of 11.
It takes more than a low valuation to make a stock a good investment, though. Cheap stocks, and entire markets, often end up in the bargain bin for good reason. When looking for buy candidates, it’s wise to focus on low-priced companies that also have improving earnings and upward share price momentum - a sign that investors are beginning to wise up to the valuation discrepancy.
With that in mind, we asked analysts at Morningstar to screen their database of roughly 6,000 foreign companies listed on U.S. markets for ones that traded at least 500,000 shares a day in the three months through Oct. 31, had a market value of at least $3 billion and had the following other characteristics:
* Earnings growth per share that was higher during the last four quarters than the average for the preceding three years.
* A ratio of price to cash flow - a valuation measure similar to the price-earnings ratio but less likely to be distorted by accounting gimmickry - that’s lower than the average for companies in the broadly diversified MSCI World Index.
* Share price performance that lagged MSCI World in the five years through Oct. 31 but that showed recent improvement by outperforming more stocks in the Morningstar database over the last three months of that period than for all of 2013.
The result is an eclectic mix of 10 companies scattered across three continents and doing business in seven of the 11 economic sectors into which Morningstar divides the business world.
Three companies involved in communication services made the list: China Unicom Hong Kong Ltd and a pair in Brazil, Oi SA and Telefonica Brasil SA. Two others are South American electric utilities: Companhia Energetica de Minas Gerais Cemig in Brazil and Enersis SA, which is based in Chile and has operations across the continent.
The final five are ACE Ltd., a Swiss insurance concern; Canon Inc., a Japanese manufacturer of office equipment and cameras; Japanese carmaker Honda Motor Co. Ltd. ; Ensco PLC, a Canadian oil drilling company; and Siliconware Precision Industries Co. Ltd., a Taiwan company that makes semiconductor testing equipment.
As diverse as these selections are, several share a theme. To varying degrees, they’re China plays, even if half a world away.
As a provider of wireless phone service, China Unicom is a way to ride China’s domestic consumption boom. A worrisome sign for potential buyers, though, is a heavy debt load of about 60 percent of equity, much higher than that of rivals like China Mobile Ltd. and China Telecom Corp. Ltd.. Unicom’s operating margins are lower, too.
Canon and Honda may be better bets on Chinese consumer spending. Canon recently announced plans to open its fourth manufacturing center in China and said it expected to meet a 2017 target of $10 billion in Chinese sales, roughly triple the 2012 figure. The company has almost no debt, and its stock trades near book value, the net intrinsic worth of its assets, and at barely three-fourths of annual sales.
Honda sports a similar valuation based on those metrics, although it has more debt on its books. Its earnings have accelerated in the last year, however, in part due to a depreciating yen, which allows it to price its cars more cheaply in foreign currencies. Honda reported a nearly 16 percent increase in Chinese sales in the first 10 months of 2013, compared with the same period of 2012.
Enersis and Cemig, as the Brazilian company is commonly known, may present the best risk/reward balance of the stocks selected in this screen. Both have price-to-cash flow ratios of about 4, compared with 10 for MSCI World. Utilities are usually cheaper than the broad market because their growth prospects are considered limited, but these two are cheaper even than the average electric utility. And then there’s the China connection.
China is a huge importer of industrial commodities, many of which, like iron ore and copper, are produced in South America. If demand from China rises, production is likely to do the same. That should increase demand for power from mining companies. Moreover, as the economic benefit of higher commodity prices and exports percolates through the region’s economy, it should increase power consumption by consumers and other businesses.
The calendar could also work in the utilities’ favor. Brazil is hosting the World Cup soccer tournament next year, and the Olympics come to Rio in 2016. Those events are likely to stimulate growth.
A flourishing Brazilian economy also might be expected to help the phone companies on the list, but Oi’s financial data should raise an eyebrow or two. Its debt load is six times greater than its market value, so if growth picks up and interest rates do, too, the debt could become prohibitively expensive to service.
Telefonica Brasil is different. After slipping for years, its earnings growth has picked up lately, yet it trades at a substantial discount to other phone companies. It also has much less debt.
With some exceptions, the companies in this screen are in better shape than the market is giving them credit for. That should allow them to hold up more firmly than others, even if the world doesn’t have a thriving economy to celebrate next year along with soccer.