Chapter 1

Going Global with the Top 100 International Growth Stocks

There are two times in a man's life when he should not speculate: when he can't afford it and when he can.

Mark Twain (1897)

What do most investors want? The best possible returns for the least possible worry. Our advice: Go global. In this book we have carefully chosen 100 top international growth stocks all suitable for a well-diversified portfolio: stocks that complement domestic growth stocks and, when added to a solid U.S. portfolio, should help to increase returns with no added risk.

Why Stocks and Why Go Global?

Stocks Versus Bonds and Cash

Investors often ask why they should put their savings into risky stocks instead of bonds, or instead of into bank instruments. The answer? Over time the return on stocks has been higher than on either of those alternatives. As inflation lowers the value of the dollar, the fixed rates of return offered by bank deposits and bonds actually decrease in value. Stocks, on the other hand, appreciate based on the earnings performance of the company, valuations accorded to those earnings, and inflation. Provided management is able to raise prices, maintain margins, and increase earnings successfully over time, a company's share price should -- at the very least -- provide an attractive real return over the rate of inflation.

The impact of this inflation effect is enormous. As can be seen in Chart 1, $10,000 invested broadly in the U.S. stock market during the five-year period 1991-1995 recorded an average return of 17.3% per annum, including dividends, amounting to $22,207 in all. The average annual return on bonds during this period was high at 14.7%, yielding $19,853 for the same investment but still lower than the return on stocks. The return on money market funds was even lower, at 4.5% per annum, yielding $12,462. And remember that most of the return on bonds and all of the return on money market funds is subject to income tax, while most of the return on stocks is capital gains, free of tax until a sale is made. Cash dividend payments on stock are subject to income tax but make up only a small percentage of total returns for stock holdings. Thus, because of taxes, the effective return on bonds and cash, when compared with stocks, is lower than the above figures suggest.

It is worth noting that timing can be a big factor in calculating these returns. For example, look at Chart 2. During the three-year period 1992-1994, the average annual return on stocks (including dividends) was just 6.3%, while for the four-year period 1992-1995, it was as high as 14.1%. An investor who threw in the towel on stock investments at the end of 1994, after having suffered low returns during the previous three years, would have missed out on the boom in 1995 that effectively helped to smooth stock returns back to the long-term average. That is why we say investors should invest for the long term: markets are notoriously difficult to predict. Even professionals have trouble timing short-term investments effectively.

Of course, it is also a good idea for investors to keep some cash around. We would suggest keeping enough to cover three to six months of living expenses, just in case. You never want to have to sell when the market is down and out. We also advise keeping some money in bonds -- anywhere from 10% to 40%, depending on your age, your net worth, your income, and your tolerance for risk. The lion's share of your nest egg, however, should be in stocks. Of course, if you are near or past retirement age, you may prefer a higher weighting in bonds.

Stocks Versus Mutual Funds

If stocks are the best alternative, why not invest in them through mutual funds? For some investors, mutual funds are the way to go. For example, if you are investing less than $15,000 in foreign stocks, you would be hard pressed to achieve a well-diversified portfolio (we reached $15,000 by assuming that a diversified portfolio should have at least six different stock holdings, that the average share price is $25, and that normally stocks are purchased in 100-share blocks). You also need to have the time and inclination to research and learn about companies you want to invest in. Finally, you have to be willing to follow your portfolio once you have begun investing (see Chapter 4 for advice on following foreign stocks). All that is much easier when you put money into a mutual fund: a professional will then be choosing and managing a diversified portfolio of stocks for you.

But if you're interested and have the capital to invest, investing directly in stocks allows you to make your own decisions about portfolio weightings, prudent investing, tax planning, and cost control. Besides, investing can be a lot of fun -- a challenging, stimulating, and rewarding experience.

Global Versus Domestic Portfolio

The U.S. market has been the place to be in the last few years. As can be seen in Chart 3, during 1995-1996 the U.S. stock market outperformed virtually all developed foreign and emerging stock markets. The Standard & Poor's 500 Composite Index rose by 31% per annum during the two-year period versus 17.6% for the EAFE Index (a composite of European, Australian, and developed Far Eastern markets, usually used as a proxy for developed international markets) and a flat performance for the IFCI Index (the International Finance Corporation Investable Index, based on a composite of emerging markets).

So why even bother with foreign stocks? Foreign stocks make sense in a diversified portfolio because stock markets perform differently in different periods. You may not realize it, but there have been many periods when foreign stocks have outperformed their U.S. counterparts. In fact, Charts 4 and 5 show that during the twenty years prior to 1995-1996, that is exactly what happened. From 1977 to 1988, the EAFE markets were up by 23% per year, while the U.S. market was up by 12.5% per year. Then, from 1989 to 1994, the emerging markets had their turn: the IFCI Index was up by 24% per annum, while U.S. stocks again increased by about 12.5%.

Here's a concrete example: If you had invested $10,000 in a broadly diversified international portfolio during the ten-year period 1985-1994, your investment would have been worth $66,721 at the end of the period, appreciating by 21% per annum, versus $40,455, or 15% per annum, for a portfolio based on the S&P Composite. We do not mean to frown on those nice returns generated by U.S. stocks; far from it. It just makes sense to own at least a few foreign stocks in your portfolio, given that stock markets sometimes outperform and sometimes underperform one another.

Another reason to think about foreign stocks: the United States does not have a monopoly on high-growth companies. As you read through our Top 100, you'll see how easy it is to find attractive international companies that are accessible to U.S. investors. After all, the U.S. stock market accounts for only 40% of world stock market capitalization. There is a lot of opportunity in that other 60% of the world.

Go for Growth

Year in, year out, during booms or busts, in times of political turmoil or relative calm, growth stocks have performed better than any other group. What are growth stocks? They are stocks of companies that have demonstrated over time an ability to record consistent above-average gains in sales and earnings. And in the end, superior sales and earnings growth is rewarded by superior share price performance.

To compile the list of our favorite growth stocks, we looked at a long list of growth-oriented characteristics, including consistent unit volume growth, high operating and net profit margins, an above-average ROE (return on equity), a strong balance sheet, and a commitment to reinvesting in the business. The list is dominated by companies in two noncyclical sectors: "Consumer Goods," including companies that produce foods, beverages, household goods, pharmaceuticals and health care items; and "Services," including companies in the fields of broadcasting, publishing, public services, retailing, and telecommunications. We found that companies in these fields were best positioned for growth. Most have unique brand names or franchises that help them to resist inflation, raise prices, and increase sales and earnings.

Our list also includes select "Capital Goods" companies, including firms that produce electrical and electronic machinery and telecommunications equipment. While companies in this sector tend to be more cyclical (their business expands and contracts as interest rates rise and fall), the ones appearing on our list are dominant players in industries showing steadily increasing demand trends. Take Ericsson (ERICY -- NASDAQ), for example. Ericsson is a Swedish company that has a 40% global market share in cellular and wireless infrastructure equipment, an area in which hundreds of billions of dollars are expected to be spent by the end of the century.

Finally, our list contains a few companies in sectors not normally associated with growth stocks, specifically "Energy," "Finance," and "Mining." Here we have selected companies that are exceptions to the rule -- that have demonstrated a consistently strong pattern of growth and share price performance, generally due to unique characteristics or special advantages that allow them to increase earnings at above average rates.

All of the companies in the Top 100 have weathered recessions, poor palladic environments, difficult mergers, and tough competition. And they have not only survived but prospered, recording outstanding earnings and stock price growth. If you had invested $10,000 ten years ago in the top ten companies (by market capitalization) among the Top 100, your investment would now be worth 9.5 times as much including deductions made for commissions (see Appendix B). While past performance is no guarantee of future success, these companies are rock solid and likely, in our view, to thrive for many years to come.

Digging into the Top 100

Here's a simple suggestion for investors: Look for products you like and understand. In searching out investments anywhere in the world, try to find companies that produce or distribute your favorite drinks, your favorite foods, even your favorite medicines.

Missed out on the Wal-Mart boom in the United States? How about France-based Carrefour (CRERF -- OTC), a French "hypermarket" that has successfully expanded into ten other countries, including Spain, Argentina, Brazil, China, and South Korea. This strategy of aggressive growth overseas has paid off big for Carrefour, enabling the company to increase its earnings by 20% per annum over the last ten years. Foreign markets, where the penetration of first-rate retailing operations is low, still represent tremendous growth potential for firms such as Carrefour. Retailers comprise an important part of the Top 100 list.

Now take a look at pharmaceutical giant Novartis (NVTSY -- OTC). This Swiss company was created in 1996 by two old-time industry rivals, Sandoz and Ciba-Geigy. Novartis has a 4.4% share of the global pharmaceutical market -- the second largest in the world. Each of our favorite drug companies has a strong presence in overseas markets where medical practices are less developed than in the United States and where the potential for growth is enormous. Nine of the top pharmaceutical companies in the world, in terms of market share and sales, are among the Top 100.

Near the top of our list: always Coca-Cola. "America's favorite soft drink" does a great business around the world. There are ten "anchor," or primary, bottlers in the Coca-Cola system worldwide, which are charged with expanding the Coca-Cola franchise globally. Nine of them are based overseas, and seven are publicly traded. Four of those are on our list: Coca-Cola Amatil (CCLAY -- OTC), one of the largest Coca-Cola bottlers outside the United States (in terms of cases sold), with operations in Australia, Indonesia, the Philippines, and South Korea; Panamco (PB-NYSE), the Coca-Cola bottler for Brazil, Colombia, Costa Rica, Mexico, and Venezuela; Fraser & Neave (FRNVF -- OTC), the dominant Coca-Cola bottler in Vietnam, Laos, Burma, and Singapore; and Coca-Cola Femsa (KOF -- NYSE), one of the top two Coca-Cola bottlers in Mexico and Argentina. These four companies have one thing in common: earnings growth exceeding that of Coca-Cola in the United States.

Here's another suggestion: Look for companies in attractive new industries, particularly in the service sector, that you believe have bright growth prospects. Two new areas we like are outsourcing and information technology. Try to find companies that have established an edge in their respective fields and that are well positioned to grow with rising demand trends.

One example: Germany-based SAP (SAPHY -- OTC), a leading supplier of management software worldwide. SAP lists among its clients such blue-chip companies as Coca-Cola Enterprises, Microsoft, and Deutsche Telekom. Just as the information technology sector is becoming a major factor in the U.S. economy, so too is its importance rising overseas. If anything, opportunities for growth internationally are even better than in the United States. Information technology (IT) companies are an important part of the Top 100.

Compass Group (CMSGY -- OTC), one of the world's leading contract catering companies, is another example of a business with an edge in a rapidly growing service industry. Compass Group provides food services from the United Kingdom to Malaysia for everything from horse races to school lunches. It is thriving with the corporate shift toward "outsourcing," a theme we think will continue to be important for years to come. Outsourcing firms also account for a big part of the Top 100.

In emerging markets we like infrastructure companies, companies that have been and are likely to continue to be integral to economic growth. On our list are companies such as Enersis (ENI -- NYSE), the Chilean energy giant, and Cheung Kong (Holdings) (CHEUY -- OTC), a Hong Kong conglomerate with extensive involvement in many of Hong Kong's major businesses, as well as business development in China.

Copyright © 1998 by Peggy Edersheim Kalb and Scott E. Kalb