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Trusting Foreign Numbers
Forbes: Before we get into those, when you go into these markets, the great fear is, “Can I trust the numbers?”
Riedel: Yes. Absolutely.
Forbes: How do you do your forensic research on that, that you can believe? Because we hear continued stories in China – once you start to peel away, not so good.
Riedel: No, that’s right. And it’s become even more of a concern in the eyes of the U.S. investor this year because there have been such high profile cases of overstatement of earnings or misstatement of contracts and shoddy accounting and so on and so forth.
What we do is we score companies by a corporate governance score that we’ve developed internally. It’s a two digit score between 1 and 100, which accumulates a lot of knowledge that are things that people can find on their own. Is the chairman of the board also the CEO? Is there truly board independence? Have they changed their auditors frequently over the last 10 years? We found one the other day that had changed their auditors four times in a matter of 10 years. Have they restated their numbers? Do they tend to announce mergers and acquisition activity and then never complete it?
These are red flags that we’ve found, over time, indicate that a management team is distracted or incompetent or perhaps trying to cover something up. And the chance for either a fraud or a major stumble are increased in that environment.
And then our analysts – we have the advantage of having 31 analysts in 15 countries around the world, so they know the management teams. They know their reputation in the local market. And they’ll opine about their feelings about whether the management team is reliable or not. That has proven to be a very reliable indicator of whether you’re going to have a major fraud or a scandal at one of these companies.
Forbes: Does that mean knowing how to take apart a balance sheet in a country like India or China?
Riedel: Well, you have to be able to do that anyway to assess the value of the company. The question is, “Can you trust the numbers?” I think you need to understand the relationship between actual cash balance, cash flows and what’s being reported on the P&L. So I would say not just the balance sheet, but the interaction of all three financial statements will often give you a clue to the question of whether people are actually generating the cash that they should or could, given their business.
Forbes: Did this prevent you going into some of the notable headline breakups?
Riedel: Luckily it did. We were able to predict the Satyam Computer fraud before it was announced. Sino Forest was one we didn’t have under coverage – we just haven’t even looked at it. Chaoda Modern, which is a Hong Kong listed food company, had red flags as a result of our corporate governance analysis. So we’ve been very fortunate putting this program in place to avoid some torpedo stocks for us and our clients.
Assessing Local Exchanges
Forbes: Local exchanges: Another dicey thing to go into, with manipulation and the like. How do you assess those? Whether you can, not safely, but know what you’re doing when you find those markets?
Riedel: Well, there’re very different classes. The Bovespa, for example, is so large and so deep it’s unlikely that a local player could manipulate a particular stock unless it was a very small stock. Hong Kong’s the same way – a deep, well regulated, diverse domestic market. Malaysia, Thailand, you start to get into some markets where you could have someone operating against your interests or manipulating the market in a certain way.
If you are concerned about that, you can look to the larger companies where the liquidity is such that it would be hard for someone to push it around. Or reach into the ADRs. It’s unlikely that a company would go to the trouble of having an ADR if they didn’t have the ability to avoid local market manipulation.
Forbes: In terms of big companies – you mention those – isn’t that a way to diversify? Or you feel you just don’t get the home runs with them that you do by going for some of these more obscure ones?
Riedel: Sure. Well, there’s a couple of things. A lot of American investors tend to think that if you invest in American companies that have international operations, well, there you go. I’m internationally diversified because I own Pepsi or I own Coca Cola.
The reality is that that stock is going to trade like a U.S. stock. It’s going to trade in line with the S&P – which can be good or bad – but it’s not giving you the kind of upside potential that you might look for if you want to own the Coca Cola bottler in Mexico or the Coca Cola bottler in Greece, if it strikes your fancy. There’s a lot of good companies in the local markets that I think give you better diversification than buying an American company. Even if they do have good global presence, they trade like an American company.
Forbes: Talking about local exchanges, do you feel there’re some up and comers there? Say, a city like Warsaw?
Riedel: I don’t think so. I think most of that’s been pretty set in stone at this point for the foreseeable future. The one to keep a very close eye on is Shanghai. The Chinese have a very deep commitment to making Shanghai not just the financial capital of China, but the financial capital at least of Asia.
So watch for some closer tie ups between Hong Kong and Shanghai. And what China can bring from Hong Kong’s experience of being a well trusted, well regulated, deep and broad market. They can bring that to Shanghai. That’s where you’re going to some great value going forward.
Forbes: What particular countries intrigue you now? Not so long ago, Mexico, maybe. Because you say it’s too close to the U.S. it’ll never be attractive to you?
Riedel: Yeah. Mexico is a tricky one because it is very tied to the U.S. Some studies indicate that some 80% of economic activity in Mexico is a derivative of economic activity in the U.S. So that’s not one where I think you’re getting enough diversification.
The other thing that really disturbs me about Mexico is the scale and carnage of the drug violence that has plagued that country and is in the process of hollowing out society there. Anyone who can leave is leaving. Anyone who can’t leave themselves is sending their kids away. So that’s something that does not have a firm foundation for growth that I would be looking for.
source:forbes.com
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