Investing money outside the U.S. can be a risky venture

The idea of investing in some foreign companies in order to diversify your portfolio and not be completely dependent on the U.S. economy is a good one. But international investing carries some risks.

“Many countries can be dangerous places to invest. Shareholder rights and protections you enjoy in the United States are reduced or nonexistent in many places. Placing your money under the regulatory oversight of developing economies is risky. Some countries (such as China) have created different classes of shareholders, domestic and international, and there can be no guarantee that these classes have the same rights to the free cash flows of companies.

“You also assume currency risk. The shares and earnings in other countries are recorded in the native currency, be it pounds, yen, cedi or drams. You may have done all your homework on a company and picked a winner, yet your returns might lag due to external economic factors causing the local currency to weaken against the dollar. (Of course, a weak dollar can boost earnings generated abroad.)

“Reporting standards differ. A company listed in the United States and based here must publicly report its earnings each quarter. That’s not so elsewhere. In the United Kingdom, for example, this must be done only twice a year. Few nations have reporting requirements as stringent as ours. Many don’t track insider buys and sells, lock-ups, deals with related entities, executive salaries, and dividends. Each country has its own form of Generally Accepted Accounting Principles (GAAP), which aren’t always easy to understand. If you lack experience with a nation’s accounting standards, you’re at a disadvantage.

If you are very familiar with a country and company, you may do well investing in it directly. If not, you’re not out of luck. Just zero in on multinational U.S.-based companies.

McDonald’s, for example, generates about 65 percent of its revenues abroad. Roughly half of Procter & Gamble’s revenues come from outside North America. It’s closer to three-quarters for ExxonMobil and a third for PepsiCo. Internationally focused mutual funds such as Dodge & Cox International or Oakmark International are another option worth considering.

Ask the Fool

Q: If I find a great company, does it really matter whether I buy my shares at a fair price or an overvalued price? As long as it goes up, won’t I still make money in the long run? — P.D., Bakersfield, Calif.

A: You’re right to think of the long run, but you’ll make less money if you’re buying an overvalued company. You may even lose money.

Imagine the Fingernail-on-Blackboard Car Alarm Co. (ticker: AIEEEE), which is trading at a fair price of $20 per share. If it’s expected to grow at 12 percent per year for the next 10 years, it should trade around $62 per share in a decade.

If you buy at $20 per share, your total gain over the decade will be 210 percent. However, if you pay $40 for it now, it will return only a total of 55 percent on its way to $62, about 4.5 percent per year. You’d likely make more investing in CDs, with much lower risk. Remember, too, that the stock might hit $82 instead of $62, but it might also only rise to $50.

Prudent investors aim to buy companies at a discount to their estimated fair value. If you buy at a higher price, you better be sure the firm will grow at a reliable pace.

My dumbest investment

I don’t remember how many shares of Webvan I bought. If I recall correctly, it was around $7 per share at the time. I watched it fall all the way to a dollar before selling. I bought it on a whim, as I thought the company’s premise of delivering groceries to homes was a great idea. By the time I gave the business model enough thought as to why it may or may not work, it was too late. — Shawn P., via e-mail

The Fool Responds: A company’s business model is well worth examining. Webvan’s model involved building expensive automated warehouses to sort groceries and process orders, along with spending a lot on advertising to try to get more people to switch their grocery shopping from traditional supermarkets to an online company. Many of its customers gave rave reviews to the service, but there weren’t enough such customers. Webvan failed to generate the revenues and earnings it needed to keep afloat. The stock was trading for mere pennies per share when the company filed for bankruptcy protection in 2001.