Sunday, July 19, 2009

A Barron's Pan, And Pick

The latest issue of Barron's contains an analysis of General Electric that doesn't see much good in GE's 2Q report. Entitled "General Electric Loses Spark," it digs into GE's ostensibly Street-beating earnings and discloses that it only beat the Street through a GE Finance tax credit. Had that credit not been there, GE would have missed on earnings as well as revenues.

Another stock in the Low P/E Bin was mentioned by Barron's, but favorably: the Spanish bank Banco Santander. It was praised in a subscriber's-only article entitled "The Best Bank You've Never Heard Of." [Reuters' summary here.] Santander could be called a diamond in the rough: unlike many other banks, its FY 2008 earnings were flat with respect to FY 2007's. Its 10-year EPS growth, as measured by logarithmic regression, is 15.65%: that's well above its current P/E of 7.83. EPS growth is also slightly above its P/E ratio as derived by using 10-year average earnings, translated from Euros to US$. Using Santander curent closing price of 11.37, 10-yr average earnings of 0.79 Euros, and the current Euro/US$ exchange rate of 1.4172, the resultant P/E is 10.2.

I can think of five reasons why a foreign bank, despite it seeming a real grower, would sell at a P/E (not to mention a 10-year-average-earnings P/E) that's well below its ten-year growth rate:

1. The one that the Barron's article intimated: it's not widely known, Consequently, there's little new demand for the stock to push it up to a P/E level more reflective of its growth.

2. One that was discussed in the final section of the current edition of Security Analysis: accounting and reporting standards are different for a foreign company like Santander, leading to some uncertainty about what it's really earning. Foreign companies that file 20Fs are no longer obliged to report what their earnings would have been in U.S. GAAP. In addition, home GAAP was abandoned in 2005 for the new IFRS standards. The switch-over, which was not carried back to previous years, may very well have inflated earnings. A proper reconciliation may very well require an ouside auditing team. So, as Thomas Russo emphasized in the "International Value Investing" section of the current Security Analysis, an old value-investing rule is invoked: when in doubt, discount!

3. Currency effects: A foreign investor has to bear the added risk of the euro sinking with respect to the U.S dollar. That risk may seem more like "opportunity" given the current U.S. government's fiscal state, but the US$ had risen a fair bit against the Euro in the past. Shortly after it was introduced in 1999, at about $1.20 per euro, there were many currency analysts glad to welcome it with a bullish recommendation. Instead, it fell to reach 0.843 US$ per. The Euro has actually trended up against the U.S dollar for most of the last ten years, but those intermittent falls do add a timing risk...not to mention the risk that the Euro's overall good fortune with respect to the US$ may reverse.

4. Economists' common-sense factor: if it were undervalued, then why haven't domestic investors picked up on it? They face none of the above-mentionend risks. It could be that their investment standards are old-fashioned and inappropriately conservative, but a lot of foreign-policy mistakes have been made by assuming that foreigners are dumb or backward. So have a lot of investing mistakes, as well as speculating mistakes. It could be that the needed catalyst - a group of activist value investors - is missing. Once the question "why?" is asked, though, another reason surfaces:

5. "This is not America": This line is meant in the sense it was used in an old movie, The Falcon and the Snowman. If you ever have a chance to see it, watch for that line and you'll really see what I'm about to point out (especially if you imagine the character saying it to an activist investor.) The United States, as a jurisdiction, is one of the world's most shareholder-friendly. Others aren't. Japan is well known for putting management ahead of shareholders, and Spain might be too. Mr. Russo also discussed this risk and recommended adding an extra discount to compensate for it.


The above-mentionend risks do not apply specifically or solely to Banco Satander. They apply to any foreign company, even one domiciled in my own country of Canada. Shareholders are treated fairly well in Canada, but this point doesn't speak to most of the items above.

The above list also applies to the first stock discussed in my earlier post, "Five Stocks That Leapt Out Of A Near-Term Trading Range...And One That Hasn't." Banco Bilbao Vizcaya has a long-term EPS growth rate that's almost as high as Santander's, and has a significantly lower 10-year-average-earnings P/E. And yet, its long-term chart shows a stock that hasn't done all that much, despite the favorable earnings growth combining with an overall bull market in the Euro from 2000 to 2008.

So, it's uncertain whether or not Santander, Bilbao and their likesake are unknown treasures or value traps. Their stocks' performance over the last decade, although respectable until the credit crisis, suggest that companies' performance is not adequately reflected in their stock price. I can't say that they are value traps, as they haven't gone nowhere over the last decade, but I do note a long-term discounting that a comparable U.S. company would not face.

[H/T: I found out about the Barron's article on Santander courtesy of]

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