International stocks, especially those in Europe, may be better valued than U.S. stocks and likely to outperform in the future. Among foreign companies, the incentives were not as great for CEOs to misrepresent profits so earnings haven’t been as inflated.
Looking at key ratios, U.S. stocks recently were trading at 2.7 times book value and 13 times cash flow. European stocks traded at 1.9 times book value and 9 times cash flow. The lower ratios indicate lower stock values.
Besides better valuations, other reasons for investing outside the U.S. include the growth of an “equity culture.” Europe, for example, is experiencing the growth of private pension plans, more equity financing, and better corporate governance. Non-U.S. companies are putting more emphasis on satisfying shareholders, which should lead to higher profits and stock prices in the medium and long term.
Shorter-term, the U.S. dollar may be fundamentally overvalued against most foreign currencies. A weaker dollar could be a plus for non-U.S. stocks. If the dollar loses 15 percent-25 percent of its value, versus other currencies, over the next five to 10 years, currency moves would add about two points a year to the returns of international stocks.
