Last week, I began to make the case that the investors should pay far more attention to the country environment in which prospective companies are domiciled than they, and Wall Street commonly do. Some got it; some didn’t.
I want to take the conversation to the next level of detail. Let’s approach this question by reasoning from basic principles. We know from 4,000 years of recorded history what does and doesn’t work when it comes to national prosperity. The Scriptures speak to these questions, as do the other great books of Western Civilization. The founding fathers of the U.S. have probably captured these truths better than anybody, and codified them into the Declaration of Independence and the Constitution of the United States of America.
The Great Books give us enormous amounts of insight about how to be a successful man, and about how to be a successful nation. However, there is simply no body of knowledge even remotely comparable of similar pedigree about how to be a great publicly traded corporation. The modern, limited liability, publicly traded company is rather new in human history.
Yes, there’s a slew of In Searches of Excellence and Goods to Greats, etc. which have appeared in our generation. Most of them contradict one another and have very poor track records when it comes to identifying future successes.
When it comes to knowing the right principles on which to build a prosperous nation, humanity has no excuse for choosing wrongly. But when it comes to avoiding loops of doom, deciding whether to delegate or to sweat the details, whether to synergize or specialize, whether to manage by walking around and solving problems or manage by ignoring problems and pursuing opportunities, whether to run tight ships or to inculcate chaotic innovation among armies of shorts-wearing, Ping-Pong playing, cubicle-less knowledge workers, humanity is still figuring this out—at least, I am.
As countries pursue policies of currency devaluation, country choice grows in importance. Whether you know it or not, when you buy a company, you’re buying a currency, and when you buy a currency, you’re buying the quality of decision-making of its central bankers. Every time you buy an American stock or bond, let me suggest that instead of just picturing the CEO of the company, you picture Ben Bernanke as his co-CEO, because he is. Stocks and bonds are, in the final analysis, pieces of paper promising units of currency in the future. If the company is an American one, these are promises of future dollars.
Bernanke is your business partner whether you realize it or not.
If you are a stock investor, President Obama is your business partner too, because the nature of stocks, as opposed to bonds, is that their value is determined largely by future economic growth. Washington’s growth (or more recent anti-growth) policies drive earnings trends. This is very clear in the data. Yes, some managers manage to beat the growth rate of the economy, but the majority cannot. This isn’t Lake Woebegone. All the companies can’t be above average.
Please don’t misunderstand: the country of domicile is not the only thing which matters in portfolio construction. It is however, one of the biggest things. And the other big things such as global systemic risk and hegemon country risk (more on that later), and those non-company specific factors generally dwarf the risk due to company choice in a well diversified portfolio.
These macro factors matter more than the same old so-and-so is a great CEO and such-and-such company has performed well in the past. If so and so is really a great CEO, she will gravitate towards companies which function in a favorable economic environment. Countries with thick layers of regulation and ‘stakeholder’, as opposed to shareholder capitalism models, repel entrepreneurial management teams. CEO compensation ceilings repel talent. Stagnant economies breed stagnant corporate cultures. Freedom attracts creative minds.
Of course the risk of being domiciled in a certain country is not the only country risk which can be applied to an investment decision: interdependence among nations is important too, and companies domiciled in one country can be strongly influenced in the short run by the economic conditions of trading partners. I call this the Hegemon Effect , and it matters quite a bit. In fact it deserves a separate series of columns all its own. But even that fact, that companies can get revenues from operations in other countries, does not obviate the importance of national regime conditions, it simply extends the principles to another level. When one country is economically dependent on a second country, the bad policies of the Hegemon country constitute a risk factor for the dependent country. Nevertheless, the freer the economy of the peripheral country, the more agilely they can adapt to problems among their trading partners, and the more quickly they can bounce back.
Here’s my simple proposition: before you ask whether a company is a good bet, ask whether the currency in which it is denominated, the legal environment in which it was created, the economic environment in which is subsists, and the tax burden which it (and you as a co-owner) will be expected to bear, represent an environment conducive to prosperity. For investors in the world of today, which is a world in which 17 countries are more free than America is, that’s job one.
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Mr. Bowyer is the author of "The Free Market Capitalists Survival Guide," published by HarperCollins, and a columnist for Forbes.com.
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