Should You Target Companies Whose Home Currency Is Weak or Strong?

When it comes to investing, currency matters.

The Motley Fool

When it comes to investing, currency matters. Yet too many investors simply fail to take foreign exchange movements into account.

Perhaps some find it too complicated. Others may think currency swings won’t affect them, because they only invest in their home country.

But foreign exchange will have a major impact on your long-term returns, especially in days like these, when markets are highly volatile.

Cheap and cheerful

You only have a look at post-Brexit Britain to see the impact a sharp currency swing can have on stock markets.

When Britons shocked the world by voting to leave the EU on 23 June, the pound crashed.

Some expected stock markets to crash as well, but instead a strange thing happened: the FTSE 100 benchmark index soared to near its all-time high. Investors around the world couldn’t get enough of UK shares.

Why? Because the 20% drop in the pound made it 20% cheaper to buy top-level companies that were listed in the UK.

Foreign affairs

It was more than that. The FTSE 100 may be based in London but it is a truly global index, as constituent companies generate more than three quarters of their earnings overseas.

Those earnings are now worth 20% more when converted back into sterling, boosting company profitability. Total sales may also rise, as UK exports are now cheaper to buy.

This must be offset against the fact that UK companies may see their costs increase, because imported raw materials are more expensive.

Buy low, sell high

A number of FTSE-listed companies price their dividends in euros or dollars, offsetting the shock of weaker sterling.

If Brexit proves less painful than many expect and the pound recovers as a result, you could an extra growth kicker, as today’s share purchases will be worth more when translated back into your home currency.

Investors chose to put their money into the UK because the currency was weak, but does it always work out that way?

Top dollar

Today, the dollar is strong, and this can have some disadvantages. First, your foreign investment money doesn’t travel as far when buying US companies.

Also, US companies’ overseas earnings are worth less when converted back into the home currency.

That is fine if the greenback stays strong, as any company dividends and share price growth will be priced in dollars.

Trump that!

The danger is that the dollar might be overvalued. If the US Federal Reserve surprises markets by deciding against hiking rates in December, it could come crashing back to earth. If Donald Trump wins the US presidential election in November, all bets are off.

Buying into a strong currency is dangerous because foreign exchange fortunes can quickly reverse. However, as the world’s reserve currency, the greenback is a relatively safe long-term bet.

Currency trap

The contrarian investor might therefore want to hunt for countries with weak currencies in the hope of picking up more stock then cashing in as its coin swings back into fashion.

The danger is that currency weakness is often a sign of economic weakness, which means you could be walking into a foreign exchange value trap. Right now, the UK might be that trap.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

think thought consider
Stock Market

Billionaires Are Selling Apple Stock and Picking up This TSX Stock Instead

Billionaires like Warren Buffett continue to trim stakes in Apple stock, with others picking up this long-term stock instead.

Read more »

ways to boost income
Dividend Stocks

1 Excellent TSX Dividend Stock, Down 25%, to Buy and Hold for the Long Term

Down 25% from all-time highs, Tourmaline Oil is a TSX dividend stock that offers you a tasty yield of 5%…

Read more »

canadian energy oil
Energy Stocks

Is Baytex Energy Stock a Good Buy?

Baytex just hit a 12-month low. Is the stock now oversold?

Read more »

Start line on the highway
Dividend Stocks

1 Incredibly Cheap Canadian Dividend-Growth Stock to Buy Now and Hold for Decades

CN Rail (TSX:CNR) stock is incredibly cheap, but should investors join insiders by buying the dip?

Read more »

bulb idea thinking
Dividend Stocks

Down 13%, This Magnificent Dividend Stock Is a Screaming Buy

Sometimes, a moderately discounted, safe dividend stock is better than heavily discounted stock, offering an unsustainably high yield.

Read more »

a man relaxes with his feet on a pile of books
Investing

Outlook for Sun Life Financial Stock in 2025

Sun Life is up 25% this year. Are more gains on the way?

Read more »

Canadian Dollars bills
Dividend Stocks

Invest $15,000 in This Dividend Stock, Create $5,710.08 in Passive Income

This dividend stock is the perfect option if you're an investor looking for growth, as well as passive income through…

Read more »

woman looks out at horizon
Stocks for Beginners

Here’s How Much Canadians at 35 Need to Retire

If you want to create enough cash on hand to retire, then consider an ETF in one of the safest…

Read more »