Bidding adieu to our overseas stocks

Most Australian stock portfolios have had a tough run lately. Bank share prices have had a reality check after valuations got ahead of themselves. A combination of falling commodity prices and mothballed oil and gas project developments has ripped through the resources and mining services sectors. Furthermore, reduced growth expectations have knocked some of Australia's highest quality stocks from their perch.

If you've been diversified abroad, particularly in US dollars, then your returns are likely far better. Owning high quality businesses that provide currency diversification makes sense at virtually any time, particularly when self managed super funds have just 1-2% of their assets invested offshore, despite retirees needing to preserve their purchasing power abroad more than ever.

But with China's economy likely slowing faster than most estimates it's not too late to act, assuming you have modest expectations for stock returns given current valuations. 

While our overseas stock coverage is ending, this isn't the time to toss your overseas holdings if you understand the risks and opportunities each business faces. In six months we've made 16 Buy recommendations, only ceasing coverage of Avid Technology after suffering a small loss.

Let's update the investment case for each recommendation, but note there's no news for the five stocks recommended recently in the Bargains in the oil patch special report (see Bill Nygren's recent comments on National Oilwell Varco at the end of this review), RIB Software or Applus Services. For these stocks, it's as you were.

As for Wells Fargo, its stagnant share price belies the company's longer-term opportunities. While rivals like JP Morgan turn away deposits as they're not immediately profitable at such low interest rates, Wells Fargo's trillions in deposits continue to grow in the high single digits, with loans growing at a slightly lower rate.

While they might not be profitable today, management knows if those depositors eventually use more services (the average Wells customer uses eight compared to two or three at any one institution in Australia) then those customers will become very profitable. There's also a massive generation of Echo boomers that are on the cusp of starting families after putting major life decisions on hold during the GFC. That should increase demand for housing and all sorts of personal loans.

A 1% increase in interest rates could also increase profits by $1 per share, putting the company on a low price-to-earnings ratio of 11. The timing of these tailwinds is uncertain but the potential returns are worth waiting for. If you're patient and you like to own the best in the business then Wells is worth hanging on to.

It's the same story for Bank of America, which has finally put its litigation problems behind it. Over the next two years we should see litigation and other costs fall and legal fines and penalties should stop sucking the company dry of cash. Earnings per share should get to around $2 (and that's without higher interest rates or a better housing market), which would put the stock on a price-to-earnings ratio of a bit over eight.

The company's return on equity won't return to pre-GFC levels, but as its true earnings power emerges and dividends start increasing I expect Mr Market will eventually be prepared to pay 40-50% more than the current price.

AIG's stock price has performed adequately and is currently sitting in Hold territory. There's no rush to sell this business, particularly when it's yet to benefit from higher interest rates and there's still plenty management can do to create value. Bill Nygren of Oakmark recently summed up the investment case:

'At the end of March, AIG's stated book value was $80 per share. Most analysts tend to discount stated book and instead focus on book value ex- AOCI and DTA, which is just $61. Oversimplifying, that means excluding unrealized gains in its bond portfolio and excluding the value of its deferred tax asset (because of historical losses, AIG won't be a cash taxpayer for years). Even using the $61 number, AIG stock at $58 to us looks inexpensive because we believe that an insurance company with a valuable brand name ought to be worth somewhat more than book value.

Looking out seven years, let's assume that AIG averages after-tax earnings [per share] of $6 per year, or a total of $42 of income. That level of income would be enough to exhaust its tax loss carryforwards, so the $11  [per share] DTA would turn to cash. Additionally, over seven years most of the unrealized bond gain would also be realized. There will no longer be a reason to report three separate book value numbers. The $80 GAAP book [value per share] would grow to $122, and the other book value numbers would also grow to roughly that same number (for this example I'm ignoring the small dividend AIG currently pays). On that basis alone, AIG stock would be positioned to more than double over seven years just by returning to book value.

What that analysis ignores, however, is what management will do with the excess capital the company earns. One of the reasons we own AIG is that management has demonstrated a willingness to grow by shrinking – that is to grow per-share value by reducing the shares outstanding rather that attempting to grow the size and value of the total company. Because AIG sells for less than book value, each share it repurchases increases the book value of the remaining shares. Because of that, our expectation is that seven years from now AIG will have fewer shares outstanding than it has today, and book value per-share will be higher than the numbers in the prior paragraph.'

If I owned every share of Leucadia I certainly wouldn't sell them at the current price, either. Its price-to-tangible-book value of 1.1 is almost the lowest it has ever been and suggests management is going to destroy value and/or that the company's large investments are worth less than their accounting values. That's highly unlikely and the chance of losing money over the long term seems remote, as the recent investment in FXCM shows.

The company currently has a lot of cash that's weighing down return on equity, which should improve in the long run as management finds attractive investment opportunities (a bear market would help, but Leucadia's share price wouldn't be immune).

Some of the company's large investments have plenty of room to improve (National Beef should emerge from drought conditions, soon after which it's likely to be sold) and, while results from investment bank Jefferies will be volatile, we expect the value of the franchise to increase. Over time we'd expect to find better opportunities than Leucadia, but right now it's hard to find a company with better management valued so cheaply.

Carrols Restaurant Group's share price has increased 46% since our original recommendation as sales from its refurbished stores increase. We recommended this stock because the potential returns could be large if its first class management (which has a decent stake in the business) was able to rejuvenate the business. Having recently taken on more debt at lower interest rates the company has ammunition to refurbish many more stores. But it's important to remember just how competitive the fast food industry is, not to mention the company carries plenty of debt and isn't yet profitable.

It's still early days for this business and its results could be extremely volatile, so make sure you respect your portfolio limit and look out for the upcoming results. If sales are weak in any way the share price could fall swiftly given the high expectations currently baked into the company's valuation, but I wouldn't recommend doubling down.

Countrywide PLC had been the best performing recommendation but the stock price has dropped over 10% recently. The initial enthusiasm following the UK election evaporated last week when the government announced that it would reduce the maximum tax rate used for interest costs deductions on negatively geared property investments to 20%, thus making it much less attractive and slowing Countrywide's rapidly growing rental business.

Given the UK has a similar property culture to Australia's the initial impact may not be as bad as some suspect given most property investors will do whatever they can to stick with property investments. But if returns dwindle over time (perhaps if higher interest rates increase borrowing costs) then we may see a cultural shift away from property investment.

High property prices, particularly in London, are also weighing on the stock. Over the next year we should get a better idea of whether our initial investment case (that property transactions in regional areas would pick up as the economy improved) is right or not. Interest rates remain low, the UK economy is ticking over nicely and banks are lending more, so hopefully property transactions and Countrywide's profits will pick up in 2016.    

Lloyds Banking Group burst out of the gate when it was upgraded in Lloyds is no dark horse but has fallen a little recently for many of the same reasons as Countrywide. In addition the UK banks were slugged with an 8% levy as the UK Government looks for ways to balance its books. The banks remain an easy target.

We haven't changed our valuation as the banks will likely pass on some of the levy to customers and Lloyds' legacy issues (payment protection insurance, for example) should eventually go away. Once a big chunk of the company's £8bn or so of underlying cashflows eventually starts flowing as dividends, the share price should breach one pound and you'd still own the UK's most profitable bank at a reasonable price.

Oracle's share price has fallen about 10% recently following a soft outlook for earnings growth. The actual results were better than they appeared once you strip out the impact of the strong US dollar, but most importantly cloud services – which are the future of the business – are growing strongly. 

On a forecast price-earnings ratio of 15, the company doesn't need to grow quickly to produce a decent return, but it does need to defend its market position in a highly competitive and fast-moving industry. That's why we're happy that Oracle is investing heavily in cloud services despite the impact on short-term profits. The company is a financial powerhouse that has dominated its industry for decades, but the small maximum recommended portfolio limit is there to protect you if it does succumb to the competition.

Although these stocks won't be covered in future and these are my parting words on them, we couldn't possibly sign off without mentioning a new idea. While the major western markets have shrugged off the issues in Greece and China, a high quality stock that's fallen 25% recently is US-listed Precision Castparts, which manufactures high performance aeroplane components. The share price has increased over 3,500% over the past 15 years, even outdoing Apple, as chief executive Mark Donegan has greatly increased market share with the help of acquisitions.

The stock trades on an attractive forecast price-to-earnings ratio of 16, as 8% of the company's revenue had come from the oil and gas industry where revenue is expected to slump 30%. The recent share price fall was an over-reaction given the company continues to increase market share in the latest generation of plane engines, and we expect it will be successful looking for more ways that its parts can be used to build lighter, faster and stronger passenger jets.

Lastly, I want to thank you for your support over the years, and if you've got any questions about the stocks mentioned above please post a comment below rather than through the online forum. It's been great working for Intelligent Investor for 10 years but I couldn't resist a different challenge. The decision is made easier by the fact that I'm leaving the research team in such good shape and, while the cessation of international coverage will be a disappointment for some, it will restore the team's focus completely to ASX stocks. I hope you understand the reason for the decision.

Disclosure: interests associated with the author own many of the stocks mentioned in this article.

Bill Nygren on National Oilwell Varco: National Oilwell Varco (NYSE:NOV) is a leading oil service company with dominant share in deep water drilling. I wouldn't waste much ink trying to argue this is a fantastic business, but because of strong market share, over a cycle NOV has earned a decent return on capital.

Right now the oil industry has pulled back on drilling, especially deep water drilling. But NOV has a very strong balance sheet and the stock sells for less than book value. We expect the price of oil to be higher five years from now and with a higher commodity price, also expect higher drilling activity. When that activity returns, NOV is highly likely to capture its share, and again earn a high return on invested capital.

Importantly, the strong balance sheet gives it the ability to not only survive the current environment, but to opportunistically take advantage of companies that don't enjoy an equally strong financial position. As we wait for a drilling recovery, NOV should remain decently profitable from its aftermarket business, so even in a tough environment we expect book value per-share to continue growing.'