A $43 billion value investor’s winning formula for buying unloved foreign stock

Investing

Sarah Ketterer’s Causeway Capital is trouncing the competition using a mix of quantitative and fundamental analysis to find bargains among European stocks like Rolls-Royce and Ryanair.
Causeway Capital CEO Sarah Ketterer looks for gigantic yawning gaps in stock valuations.  MICHAEL THAD CARTER FOR FORBES

In the 15 years since the Great Recession, American exceptionalism has carried the stock market.

Since the beginning of 2009, the S&P 500 Index has soared nearly fivefold, while the Euronext 100 tracking the performance of Europe’s largest stock exchange is up a more modest 145%, or a mere 6.3% annually.

Sarah Ketterer, CEO of Causeway Capital Management, thinks most of the gloom is in the past for international stocks and is now eyeing a buffet of companies with glaring valuation gaps compared to U.S. peers.

The Los Angeles-based firm managing $43 billion is already outperforming with its portfolio of undervalued stocks it selects through a blend of quantitative screens and fundamental analysis.

Causeway’s main international value equity strategy has generated a 17.6% annualized net return for the last three years, trouncing the MSCI EAFE index tracking international stocks in developed markets by eight percentage points.

It’s up 24.5% this year through July, beating the index’s 15.8% gain and even outshining the S&P 500’s 19.5% gain during that span.

“The benefit of investing internationally is finding less well-trodden, less well-understood companies listed in markets that many people are neglecting,” says Ketterer.

“What the non-U.S. environment has to offer investors who are willing to look carefully for signs of improvement is the delta, the change between where a company is today versus where it could be in two or three years as management is even more focused on the bottom line.”

One of Causeway’s biggest winners of the last year has been Italian bank UniCredit, whose shares are up 64% in 2023 and 160% since last September.

Causeway’s portfolio manager in charge of overseeing the financials sector, Conor Muldoon, became bullish on European banks after they cratered in 2020.

The European Central Bank asked banks on the continent in March 2020 not to pay dividends or buy back stock for the rest of the year, and it later put a dividend cap in place for most of 2021 to ensure that banks would be able to withstand losses and continue issuing loans during the pandemic.

The regulations caused an intense selloff for the banks’ stocks, but their cash piles continued to grow, buoyed by trillions in European Union spending to keep businesses afloat and people employed.

UniCredit has started to put that cash to use, reimplementing a dividend targeting 35% of net profits and buying back $2.6 billion of stock so far this year.

“This is where non-U.S. just hands you a gift. U.S. banks are still trading at a significant premium to book value. Meanwhile, many of these large European banks are trading at 30% to 40% of their tangible book,” Ketterer says. “There was just a gigantic, yawning gap in valuation for these that became irresistible.”

Ketterer has been investing in global stocks since starting the international equity arm at value shop Hotchkis & Wiley, cofounded by her father John Hotchkis, where she started working in 1990 after brief stints in investment banking and as an entrepreneur building databases of European company information.

She split off from Hotchkis & Wiley to found Causeway with her business partner, Irish-born Harry Hartford, in 2001.

Causeway’s quants screen more than 3,000 stocks with market capitalizations of at least $1 billion, looking at metrics like earnings yields compared with bond yields within a country and low price to cash flow or enterprise value to Ebitda multiples to find the best values.

Its analysts research every stock that gets through the screens to come up with a two-year price target for each stock at least once per quarter, then Causeway overlays a risk model and ranks the stocks by their implied two-year risk-adjusted returns.

The ranksheet provides a roadmap for which stocks should have the biggest weights in the portfolio and which should be added or subtracted as they move up or down the list.


Causeway’s foreign faves

These 10 stocks are the largest holdings in Causeway’s flagship international value strategy as of June 30.

Name CountryDescriptionMarket cap (bils)
Rolls-Royce HoldingsUnited KingdomAeroplane engine manufacturer$21.5
Samsung ElectronicsSouth KoreaConsumer devices and semiconductors$299.0
UniCreditItalyCommercial bank$46.1
EnelItalyElectricity and gas provider$66.8
Roche HoldingSwitzerlandBig pharma drugmaker$241.0
SAPGermany Enterprise software developer$163.2
Reckitt BenckiserUnited KingdomProduces consumer goods like Lysol$51.5
DanoneFranceGlobal food and drink distributor$36.8
BPUnited KingdomOil and gas giant$102.5
Ryanair HoldingsIrelandLow-cost European airline$19.5
Source: causewaycap.com

Its $22 billion (assets) international value equity portfolio has returned 7.4% annually since inception, beating its benchmark’s 5.6% gain.

The firm’s $3.1 billion global value strategy, which invests in some American stocks, has been even better, returning 9.5% annually since inception in September 2001.

Causeway laid the foundation for much of its recent performance during the spring of 2020, buying up battered travel and leisure stocks during the early months of the pandemic.

One was Ryanair, a budget airline based in Dublin offering flights throughout Europe, which lost half of its value in the span of a month as travel shut down.

Causeway’s analysts never doubted its balance sheet strength and after the stock more than doubled in the next year, they pared back their position.

Causeway scooped up shares of Irish budget airline Ryanair after they fell 51% during the pandemic. PHOTO BY NICOLAS ECONOMOU/NURPHOTO/GETTY

“The world was coming to an end, and our job then was to decide if that was actually the case. If the world comes to an end, it doesn’t matter what’s in our portfolios anyway,” says Ketterer, “but it seemed very unlikely to us that there’d be no vaccine.”

Ketterer’s team had a chance to revisit Ryanair last year when the war in Ukraine disrupted travel to Eastern Europe on the heels of another Covid outbreak, and the stock was slashed in half again.

It has yo-yoed back with a 33% gain this year and was one of Causeway’s 10 largest holdings after the first half.

The largest piece of Causeway’s portfolio today is London-based Rolls-Royce Holdings, which manufactures engines for civil and military airplanes and is no longer affiliated with the luxury car brand, which it sold off to BMW in 1998.

Causeway first initiated a small position in the company in 2018 when problems with its Trent 1000 engines were causing shares to fall, but the gamble didn’t pay off.

The stock fell 18% in 2019, and the bottom fell out in 2020 with a 53% drop. Rolls-Royce gets paid by the hour its engines are in use, and fewer planes in the air during Covid meant less revenue.

It had to announce plans to raise $6.5 billion in September 2020 to survive the cash crunch.

Causeway responded by buying more, owning as much as 12% of the company.

Jonathan Eng, a fundamental portfolio manager at Causeway overseeing industrials, energy, and consumer discretionary stocks, said the firm worked behind the scenes to install a new chairwoman in June 2021 and a new CEO in 2022.

Rolls-Royce has improved its pricing and reliability and reduced its cost of repairs under new management, helping its first half revenue this year grow 31% to $8.8 billion and underlying operating profit grow fivefold to $856 million. The stock is up 134% year to date.

“We were a bit proactive with Rolls-Royce to guide that company to make the right choices and changes, and they have,” says Eng. “They’re on their own now and they’re doing great.”

Taking an “activist” investing role isn’t unusual for Causeway, especially among its large holdings, and its portfolio managers are in regular contact with leadership at the stocks they’re researching.

Ketterer notes that management teams in foreign countries have traditionally had less skin in the game than in the U.S. out of cultural stigmas around greed, receiving less generous stock compensation packages.

That’s beginning to change overseas, and she expects leaders to manage companies more efficiently as a result and make creating value for shareholders a top priority.

“We’re not capable of managing the business, but we know what good management looks like, and we know what effective execution in terms of earnings progression looks like,” she says. “If an investment manager is not making demands of the business and then holding the management of the company accountable to reach those goals, you might as well just invest passively.”

This article was first published on forbes.com and all figures are in USD.

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