Why Own International Companies?

When US stocks have outperformed for as long as they have—creating the world’s first trillion-dollar companies in the process—it’s easy to forget that plenty of highly profitable businesses exist a long way from Silicon Valley or Seattle.

While US companies account for just over 60% of the market capitalization of the MSCI All Country World Index, their weight is a tad misleading given that a few technology giants—Alphabet, Amazon, Apple, and Microsoft—weigh heavily on the scale. Together, those four are valued at nearly US$8 trillion, more than the next 15 largest US stocks combined.

Even if the US features most of the world’s biggest companies, it’s hardly the exclusive repository of the best ones. Using cash flow return on investment, rather than market value, as our measurement reveals that the majority of the most profitable and capital efficient businesses in just about every sector are located outside the US. The only exceptions are two areas where US companies are clearly dominant—Information Technology and Health Care.

Source: FactSet, MSCI Inc.; Harding Loevner, HOLT database.

Of course, profitability alone doesn’t define the best companies. As quality-growth investors, we examine a broader set of characteristics to determine business and management quality as well as long-term growth prospects. And still, the data show that regional diversity wins out: About three-quarters of large-cap stocks in the top two quintiles of our quality and growth rankings are non-US firms, increasingly anchored by emerging markets such as China.

Investors are naturally biased toward their home territory, which is easy to do when it is giving an electric performance. For the US, that’s been the case for more than a decade as the economy recovered from the Great Recession and smartphones, digital advertising, mobile shopping, and workplace productivity tools—areas dominated by a handful of American giants—became ingrained in daily life.

This has left international markets with more attractive share prices relative to the profitability and cash flow of their underlying businesses. We can’t predict when international markets will rise again, but we do think fundamentals and valuations ultimately drive stock performance. The valuation spread between US and international stocks today happens to mirror the gap that existed in 2001, which ushered in a period of international outperformance.

Eschewing stocks in the rest of the world not only misses out on the diversification benefits but also ignores an attractive set of companies whose valuations may be poised to rebound.

What did you think of this piece?

OOOM featured image

Small Caps: Adventures in Fundamental Research

How do you begin to research a company when so little information is readily available beyond a name and a set of regulatory filings? This is the challenge that defines small-cap investing, an asset class that invariably entails an adventure in fundamental research.

The superheroes of the stock market—mainly US corporations valued at or close to a trillion dollars—tend to dominate investment news and research. And yet little-known small companies—often based outside the US—that never generate a headline remain some of the most vibrant sources of innovation. If the biggest large caps sell the finished products that investors and consumers know well, small caps often occupy a small niche along the global supply chain, providing a critical piece of technology known only to its intended audience.

OOOM featured image

Macro Do’s and Don’ts

This commentary is excerpted from the Harding Loevner Third Quarter 2022 International Report.

One of our more acid-tongued colleagues likes to observe that “just because we don’t do macro, it doesn’t mean the macro cannot do us.” The observation is a challenge to our bottom-up investment philosophy and merits a response. What does his comment really mean? Is he correct?

OOOM featured image

Does the Equity Market Know Something the Fixed Income Market Doesn’t?

Despite recent volatility the bond market has yet to lose its composure over the multi-decade high in inflation. In the US, ten-year Treasury yields have risen, but only to levels they reached prior to the pandemic, and, while ten-year real yields have been a little perkier, they are still below zero. As a result, the longer-term inflation expectations baked into today’s bond prices remain bunched up around 2% despite headline inflation running at over three times that rate. Short-term yields anticipate a series of hikes in the federal funds rate, the central bank’s standard response to persistent inflation, but even forward curves expect short-term yields to top out at only around 2.5%, within spitting distance of where they peaked back in 2018 when inflation was slumbering at 2%.