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By Paul R. Beirne

It's common knowledge that industries are "globalizing"; that country borders are becoming more and more artificial in business. In this environment, many investors are asking why they can't get effective international diversification by buying the stocks of American companies that do a lot
of business overseas. In a nutshell,
here's why.

It's not that U.S.-based multinationals available for investment are hard to find. Almost a third of the names in a commonly used database of major American companies generated more than 60% of their 1996 sales outside the U.S., including Coca-Cola, Exxon, IBM, Colgate-Palmolive--some of the most famous participants in a variety of industries. Many more, such as Eastman Kodak, Dow Chemical, McDonald's, and Philip Morris, earned at least half their revenues abroad. And foreign revenues are growing: Between 1990 and 1995, overseas sales grew from 61% to 70% of Coke's business, 54% to 63% of Motorola's, and 55% to 65% of Digital Equipment's. With all this foreign money pouring into American firms, why bother with foreign companies at all? There are
three reasons.

Most Stocks Are Foreign. The world of stocks is no longer made in America. Whereas two-thirds of the value of the stock in the world traded in the U.S. in 1970, foreign-traded stocks now represent some 60% of global capitalization. And foreign companies dominate a wide range of industries, sometimes to an extraordinary extent (Figure 1). So the first thing to understand is that you limit your opportunity even for industry diversification if you invest only in the U.S. market.

The Home Market Is the Main Influence on Any Stock's Performance. Second is the fact that the main determinant of a stock's return is the performance of the market it trades in, regardless of where its revenues are earned. Stocks like Avon, Coca-Cola, Colgate-Palmolive, and Exxon march to the drum of the S&P 500; their performance depends to a great extent on how American investors are reacting to economic trends that affect the U.S. The extra diversification that is one of the main advantages of global investing fails to materialize when you hold only U.S.-traded companies, even when their operations span the world.

To demonstrate, we hypothesized an equally weighted portfolio of 10 of the best-known American companies with extensive foreign operations, and studied how closely their performance tracked the S&P 500 from 1975 through year-end 1996. We also tracked the Morgan Stanley EAFE index of major stock markets in Europe, Australia, and the Far East--the standard proxy for the major foreign markets. The U.S. multinational portfolio displayed a correlation of .90 out of a possible 1.00 with the S&P 500, compared with a weaker .60 correlation between the S&P 500 and the EAFE markets. In our analysis, correlations between investments must be below .70 to provide effective diversification. You need to own investments that will perform differently enough at the same points in time so that your overall portfolio will grow at a steadier rate than otherwise. Stocks trading in different nations tend to provide far more of this benefit than stocks that all trade in the U.S. market (Figures 2 and 3).

Different Markets Become Attractive at Different Times. Finally, while diversification largely affects the risk side of the investment equation, there's an advantage in global investing that affects the reward side as well, especially if you're a value investor--that is, if you seek out stocks priced low relative to their companies' estimated long-term earnings power. Perhaps nothing better illustrates the fact that investment value shifts around the world over time than the pricing of U.S. and Japanese stocks at the end of third-quarter 1997--the typical stock in our market at 3.9 times book value, the typical Japanese stock at 2.0. Who'd have believed this was possible a decade ago, when Japan seemed poised to dominate world industry? Indeed, on a price/book-value basis, the U.S. was the most expensive major market in the world.

And just as investment value moves from market to market, so does superior performance. Last year, the U.S. and European markets shared the lead; in 1995, the U.S. had few rivals. But the year before, and over the two years before that, the world's emerging markets were the best place to be. (Including the emerging markets in your portfolio also gives you participation in their growth, which, though upset in second half 1997, has tended to outpace the developed world's over time.) And so holding stocks from many nations works for you as no combination of single-market stocks can, be they local or worldwide companies. This strategy increases your opportunity and reduces your risk. *

Paul R. Beirne, CPA, is a financial
advisor and principal in the New
York office of Sanford C. Bernstein & Co., Inc.

Milton Miller, CPA
William Bregman, CPA\PFS

Contributing Editors:
Alan Fogelman, CPA
Clarfield & Company PC

Paul R. Beirne, CPA
Sanford C. Bernstein &
Co. Inc.

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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