Morningstar - Q3 2021 - 73

a broad international mandate, targeting highquality
companies with defendable competitive
advantages and strong pricing power in
industries with high barriers to entry at Fidelity
International Growth FIGFX and International
Small Cap Opportunities FSCOX.
Our discussion took place on May 27 and
reflects performance and valuation info as of that
date. It has been edited for length and clarity.
Andrew Daniels: We often hear that non-U.S. stocks
are more attractively valued than U.S. stocks.
What are the differences among markets that explain
this view?
Pradipta Chakrabortty: First, the aggregate
valuation measure on the broad index level is not
an apples-to-apples comparison. There are
different sector mixes in the U.S. versus the EAFE,
or the emerging-markets benchmarks. The U.S.
has higher weights in the tech industry; FAANGs
contribute to a large part of this. And if you
disaggregate tech, U.S. has much more software
and cloud-based services, versus more-cyclical
hardware and semiconductors that have a
large weight in the emerging markets. That largely
explains the difference in valuation. That said,
in emerging markets, consumer discretionary
stands out as cheaper compared to the U.S. Banks,
especially Latin American banks and ex-Chinese
Asian banks, are also relatively attractive.
Jed Weiss: Anecdotally, I don't think there's
much valuation discrepancy among big
multinationals, irrespective of where they're based.
Having said that, I do think there are some
significant pockets of inefficiency within the
international markets that are a lot harder to find
in the U.S. In Japan, small- and mid-cap
stocks have run in the last five years, but this is
following a 25-year bear market. It's still a
land of opportunity. You can still find companies
that have never lost money that are trading
at negative enterprise values. There are a lot of
stocks there that I think would trade at a
different multiple if listed on another exchange.
You can make a similar argument about Taiwan.
There are also a number of growth-related trends
that are at more nascent stages internationally
than in the U.S. One example: stocks benefiting
from the transition from on-premises to the
cloud. We all know the Adobe ADBE story. They
demonstrated that the total addressable
market after transitioning to the cloud can be a lot
higher than it was in an on-premises world.
In Europe and Japan, the same economics should
play out over the coming year, but the
market has been slower to understand this.
Elizabeth Desmond: The U.S. market's up
something like 13% annualized over the past 10
years-that's a very high return. Japan is
up by half that. And the U.K. is up only a quarter
of that. So, you'd expect to see that the U.S.
market's profits have grown much faster. But, if
you look at real annualized EPS growth, it
has been similar to Japan and the U.K. over that
time period. There's clearly been multiple
expansion in the U.S.
In fact, Japan has seen some of the fastest
earnings and dividend growth over the last 10
years globally. There are also companies
with fantastic balance sheets. Within this market
we've been able to identify some very
good opportunities with attractive valuations.
Coming back to Europe, as I am based here
in the U.K., I have to be mindful about potential
home-country bias. With the challenges
that the U.K. has experienced with Brexit, returns
have been relatively low over the last 10 years,
particularly in dollar terms, because sterling has
been so weak. The underlying economics
aren't brilliant; I'm not arguing that Brexit's been
a boon for the U.K. economy. However, these
challenges are well known and have opened a lot
of possibilities.
Returning to Normal
Daniels: Countries are at different stages of
dealing with the pandemic. How does that factor into
your analysis?
Chakrabortty: Last year, we saw very strong
performance in the north Asian countries:
China, Korea, Taiwan. They have managed the
pandemic well. Those markets have seen
a short-term recovery not just in their earnings and
their outlook, but also in terms of share prices.
That is reflected in the relative valuation,
which is a little higher compared to other parts of
the emerging-markets world-like Brazil,
for example, which went through a pretty severe
second wave in the first quarter of this year.
Differences in the way these countries have
handled the pandemic have created
valuation opportunities. As long-term investors,
our job is to look through short-term impacts
and look at the long-term implications for earnings
and valuations. For example, Brazilian banks
are not discounting the significant improvements
that are likely ahead. Their stock prices
are still beaten down, even though they managed
their asset quality pretty well through the
first wave and during the second wave. India is
still going through the throes of severe
COVID. As a long-term investor, it creates
opportunities from a valuation point of view for
high-quality growth stocks.
Weiss: Stepping back, I want to acknowledge
that this is a horrible humanitarian disaster. A fully
vaccinated global population can't come soon
enough. But I'm optimistic that in the fullness of
time, the world will return to normal.
Since we had great vaccine data last fall, the
U.S. and European markets have done a
pretty good job of looking through the near-term
earnings disruption. If you're a European gym
operator, your business is still horrible and many of
your gyms are still closed. But your earnings
power on the other side of this is probably not so
different from your earnings power going
into this-and your stock price, by and large, is
right back where it was before the crisis.
Where I've found the biggest opportunities
is in companies where the competitive
landscape has shifted significantly as a result of
the crisis. Maybe a company bought out its
number-one competitor, or some of its competitors
were overlevered. Often that's happening
in the industries that were brutally hit-travel,
aerospace, commercial catering. What's
tricky is you don't see the product of that until
business normalizes. When there is no
business, it's not yet obvious that there has been
a major market-share shift.
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Morningstar - Q3 2021

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