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The Little Book That Makes You Rich: A Proven Market-Beating Formula for Growth Investing Excerpt from The Little Book That Makes You Rich: A Proven Market-Beating Formula for Growth Investing

by Louis Navellier

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Chapter Sixteen
It's a Small World After All

The World Is Global. Investing Should Be as Well.

Over the past several years, we have noticed an interesting occurrence in our portfolios. The American Depository Receipts, (ADRs) of foreign companies have begun popping up frequently in our portfolios. ADRs were specifically created to enable U.S. investors to easily buy and sell foreign stocks. There are several reasons why I like ADRs. Recent studies show foreign companies that list on U.S. exchanges are more highly valued than comparable foreign companies that don't list. Also, ADRs allow us an easy way to invest our portfolio into foreign securities, therefore tapping into these growing capital markets without the complications of currency exchange and other rules. As ADRs began appearing way too often on our buy list and too disproportionately to be mere chance, we determined that international stocks were worth investigating further. We also found that our quantitative tools worked especially well on non-U.S. stocks. In fact, our analysis worked all around the globe in both stabilized nations and fast-growing emerging markets.

As we began to delve deeper into non-U.S. issues, we found a lot of things to like about the idea of investing globally. Although the United States is one of the most innovative nations around the world, it's not the only one. New products, new ideas, and new technologies are being discovered and developed all around the world. In addition, as free trade booms, the world becomes a smaller place. A whole new world of consumer markets has opened, increasing demand for cell phones and computers, automobiles, homes, and all kinds of consumer goods and services. Banks, retailers, cement companies, and even life insurance companies have sprung up all around the planet and their burgeoning new markets of hungry consumers allow them to grow much faster than their U.S. counterparts. We also discovered, to my surprise, that 10 of the world's largest companies are located outside the United States. They may do a significant portion of their business in the United States, but home is on another shore. According to Forbes magazine, the largest construction, auto, business equipment, and food companies are all non-U.S. companies.

To our delight, we also found that one of the biggest hurdles to global investing for folks like us who rely on extensive examination of quantitative and fundamental data has fallen by the wayside over the last decade. Until recently, information on day-to-day non-U .S. stock prices was difficult to obtain, to say nothing of the near impossibility of accessing accurate corporate financial information. The Internet really has opened the world to almost anyone with an Internet connection, and now we can get accurate information from Hong Kong, Japan, Russia, Brazil, or any of the world's exchanges and markets with just a few clicks of a mouse. Once we had the data we could crunch it, and crunch it we did. As ranked by our quantitative grades, the top 10 percent of our global stock picks absolutely creamed the performance of the S&P 500. The top 5 percent doubled that return again. Clearly we were onto something that worked.

There are strong underlying reasons for the success of global growth investing. First, there is a sort of value bias among most global investors, leaving growth stocks less examined and researched. As a result, when the investment community finally discovers one of these gems, it tends to rocket in price. Usually our methods have already gotten us into the stock before this happens and we get to go along for the ride. We search for global stocks using the same eight tried-and-true fundamental variables and quantitative measurements that we use on U.S. stocks and it works amazingly well, uncovering even better buying opportunities.

Part of the reason for the strong performance of non-U.S. stocks is that money has been pouring into international investments. It is not that money is necessarily flowing away from the United States; it is just flowing to other places much faster. International funds have been collecting far more dollars than U.S. funds, and the strong money flow has created buying pressure in good stocks, which gives us alpha, exactly what we are looking for. According to the Investment Company Institute (ICI), there is now almost as much money in international stock funds as there is in U.S.-only funds. In fact, non-U.S. funds have outsold domestic U.S. investment mutual funds by almost 4 to 1 between 2003 and 2006. The strong flows into non-U.S. markets and stocks is a relatively new phenomenon that shows little sign of abating, especially given that many non-U.S. stocks are riding a free currency tailwind from a weak U.S. dollar.

Exchange-traded funds (ETFs) are another important new development in the fund world. Traded on exchanges and offering substantial liquidity and cost advantages over traditional funds, ETFs are a fast growing source of investment cash. The international segment also dominates this area with much more cash flowing into international ETFs than U.S. indexes.

There are several reasons for this cash flow change. One of the more obvious is that investors like to diversify their holdings. Most financial advisers today suggest that their clients have some exposure to non-U .5. assets. In a smaller, more accessible world it makes sense for investors to go wherever opportunity presents itself.

Another significant reason for the money flow into non-U.S. markets and stocks is the Sarbanes-Oxley Act. Sarbanes-Oxley has led to a reduction of the number of international companies that want to list in the United States in the form of an ADR share (the media have reported extensively on the issue). With fewer ADR shares available and more money pouring into international stocks than ever before, the remaining ADR shares have soared in recent years. Ironically, Sarbanes-Oxley has effectively helped to reduce the number of ADR shares and artificially boosted the remaining ADR stocks. Sarbanes-Oxley tightened the reporting standards for companies listed in the United States and compels chief executives to sign and personally vouch for their accounting reports and releases. Many non-U.S. companies have not been interested in being this exposed to the U.S. legal system. They are well aware that the United States is the world's most litigious society and they simply have no interest in being exposed to it. As a result, many have left U.S. markets and many that might have listed their shares in the United States no longer bother. Both Hong Kong and Shanghai did more IPOs than the U.S. markets did in 2006, even though the NYSE led the world in new IPOs just five years ago, before Sarbanes-Oxley was passed. As the pool of international ADRs has shrunk in the United States, the money has followed the new names to exchanges in London, Hong Kong, and Shanghai.

Because of the recent compelling reasons to invest globally, we have made a strong push in that direction. Rather than attempt to set up accounts at exchanges and brokerages all over the world, however, I tend to favor ADRs since they are a convenient way for U.S. investors to invest in international companies -- an otherwise complicated process. It is especially good to know that ADRs are traded in accordance with U.S. market regulations, so any dividend payments as well as any corporate action notification will be timely. ADRs are also convenient because they're quoted and traded in U.S. dollars on the U.S. securities markets: NYSE, AMEX, and even NASDAQ. Each ADR is backed up by a specific number or fraction of shares in the foreign company. The relationship between the number of ADRs and the number of foreign shares is often referred to as the ADR ratio. I find that using this way of investing allows me to avoid worries over the different regulations and currency fluctuations of the various markets around the globe.

There are close to 300 ADRs in our universe and I find that around 25 to 30 of them at any given time are strong growth opportunities. We diversify, of course, with a tendency to lean toward the larger countries and companies. We like the fact that many of these stocks are very conservative and often have large government ownership, which helps increase the feel-good and sleep-well factor of global investing. We also sprinkle money across some of the emerging markets as they can be like rocket ships when they perform well. We keep that portion small so that we can benefit nicely when they blast off but not get hurt when they fall back to earth. They are volatile, and we try to make that volatility work for us and not against us. We also make it a point to avoid countries that we see as anti-capitalist in their foreign and financial policies. Venezuela under Hugo Chavez comes to mind as a prime example of a place we will not invest because of this reason.

Why do we invest globally? Because it increases the number of opportunities available to us and because it works. The value bias of most international investors and the continuing enormous flows of cash toward non-U.S. markets combine to offer an incredible opportunity to growth investors. The information needed to analyze and invest in these markets is as available as is information on our favorite U.S. stocks. It's a whole new world out there and we think we should be a part of it and take advantage of all the growth opportunities ahead around the world. Billions of people will need new homes, roads, and infrastructures over the next 50 years. Billions of new consumers will want all the fancy goods and toys that western consumers have long taken for granted. There are huge new marketplaces out there, and as growth investors we can benefit as they develop.

Copyright 2007 Louis Navellier