Invest over the borders

Too many times we hear investors only focusing on local stocks. Of course this is logical as investors want to know as much as possible about in which companies they invest. The more information the better is a dominant way of how investors think. We there for see many ‘local concentrated’ portfolios which then automatically have unnecessary extra systematic risks. With this we mean that still see higher correlations per country. So in case French CAC40 goes up in many cases also the other lower local French indices go up. We don’t know what the exact reasons are for it; it might be because of the huge popularity of index trackers which just ‘blindly’ buy all that’s in a certain index.

Higher risks by investing local

If we look at our visitors on ValueSpectrum we see that the US visitors almost purely focus on the US markets, the Germans focus on the German stocks etc. for all countries. We fully understand this ‘home bias’ but we keep on warning investors that this bias decreases potential returns and also increases the systematic risks. In case the US mega caps markets go up or down we see that many other US markets behave accordingly. For this reason it’s way better to have also exposures outside the US. In case the US markets go down you are then not fully exposed to this market but your risks are spreaded. We see over the longer term that portfolios of international stocks have significantly lower systemic risks and have more upside potential because of the way bigger pool of undervalued stocks that the international markets contain. So by investing outside your country you can find better investment opportunities and the lower correlation of the foreign countries with your countries reduces your portfolio risk significantly.

Spreading is the only free lunch

“Free lunches don’t exist except spreading” is a well-known investment phrase. Many academic papers proof that portfolios with more stocks are better resistant against big shocks than portfolios with less stocks. But you shouldn’t have too many stocks either. Of course the transaction costs are on historical low levels but still each all costs count. A popular saying is that every dollar you spent can’t forever be invested. So there a must be a kind of optimum in the number of stocks in a portfolio. Most analysts and portfolio managers estimate this optimum around 30 stocks. If you have for example 50 stocks you have more transaction costs and your portfolio will behave more or less just like the markets. In that case investing in an ETF is a way better option.

Markets are a random walk on the short term

Of course it’s way too easy to say that every investor should just look for cheap stocks. But what is exactly ‘cheap’ for a stock. We have to admit we don’t really know the answer for this. Especially on the short term stocks are 100% unpredictable. Meaning they follow a random walk which is for investors totally useless to focus on. If investors ask me which stocks can rise next week I also say that nobody knows the answer to that? Especially if people look for short term investments I always say the best is then to put it on their bank account.

Look for cheap stocks

so is short term investing useless? Yes for 100%. But on the longer term we definitely see some predictability in stock returns. Famous ratio’s like dividend returns, price/earnings-ratio’s (PE-ratio’s) and book to market ratios do a quite good job on predicting returns. For example we see on a word wide scale that portfolios with low PE-ratios hugely outperform portfolios with high PE-ratios. This phenomenon is not only seen in the US but we see it all over the world. The PE-ratio is just the relative distance between the share price and the earnings per share. In case a company has an earnings per share of 1 dollar and the share price is 10 dollars, then the PE-ratio is 10/1 = 10. This means that in case the earnings per share remains stable that over 10 years the total earnings are equal to the company’s market value. So the PE-ratio can’t be too low as then companies can be taken over very easily. In case a company has PE-ratio of only 3, then an investor could buy the company and over 3 years he has his total profit equal to his total investment. So there must be a kind of minimum for PE-ratios.

On our stock filter page (http://www.valuespectrum.com/stocks_filters) you can easily search for the stocks with the highest and lowest PE-ratios, dividend returns, historical returns (momentum), solvency ratios etcetera.