subject: When To Buy Emerging Market Stocks [print this page] When To Buy Emerging Market Stocks When To Buy Emerging Market Stocks
The big-picture reasons for putting more emerging-market stocks in your portfolio are compelling enough.
But you don't need to buy into the macro argument. The micro, stock-by-stock reasons are just as compelling. Put a developed-economy stock up against a developing-economy peer, and much of the time the developing-economy stock is cheaper. Much cheaper. If you think the way you make money in the stock market is to buy low and sell high, that's a very convincing argument for emerging-market stocks.
Let's do a quick dash through the big picture for anyone who's coming in late
The world's developing economies are growing faster than the world's developed economies. Much faster in some cases: China is likely to see 10% growth in its gross domestic product this year; India could come in at 8% or above, and Brazil seems headed for better than 7%. Meanwhile, growth is projected at 1.2% for the European Union and somewhere between 2.5% and 3.5% for the U.S.
Banking systems in most of the emerging economies are in better shape than those in the developed world. The subprime-mortgage disaster and the resulting meltdown of major banks and insurance companies did relatively little damage in China, Brazil, India and the rest of the developing world.
Developing countries largely dodged the huge stimulus burdens and pre-crisis spending policies that have left governments in the developed economies carrying debt levels of 70%, 100%, 120% of gross domestic product or more. (You've got to be careful here how you do your accounting, though. You can make a case, and I have, that China is broke.)
Developing countries have, by and large, younger populations than developed countries. That's a big plus for long-term growth and means that the burden of paying for retirement and health care for an ever-larger population of oldsters is further down the road for countries like India and Brazil.
It's hard to figure out what a reasonable market multiple is for emerging-economy stocks. The Shanghai Composite Index, for example, is trading around 20 times trailing 12-month earnings. That's way below the five-year high of almost 50 times trailing earnings, so it's definitely cheaper than it was. But is it cheap in absolute terms? Got me.
But put a developing-economy stock head to head with a developed-economy peer, and the micro picture is frequently very, very clear.
Let's compare a U.S. bank, Wells Fargo (WFC, news, msgs), the fourth-largest U.S. bank by assets at the end of the first quarter of 2010, and a Brazilian bank, Ita Unibanco (ITUB, news, msgs), the largest bank by assets in Brazil.
A share of Wells Fargo went for $28.13 at the close June 10. With 5.2 billion shares outstanding, the market cap was $147 billion.
Ita's American depositary receipts, traded on the New York Stock Exchange, sold for $19.05 on June 10. With 4.5 billon shares outstanding, the market cap was $86.25 billion.
None of this really tells us anything about how cheap these two stocks are. For that we need to look at their price-to-earnings ratios and earnings growth rates, and particularly at the ratios between the P/E ratios and earnings growth. Those are called the PEG ratios.
Analysts project that Wells Fargo will earn $1.97 a share in 2010. At the June 10 closing price of $28.13, the stock traded at 14.28 times 2010 earnings per share. Analysts also project that earnings will grow by an average rate of 9.4% a year over the next five years. That means the stock traded June 10 at a PEG ratio of 1.52. (That's the forward P/E divided by the average annual growth rate.) The price multiple is 1.52 times the earnings growth rate.
Do the same analysis for Ita Unibanco. Analysts project that the company will earn $1.60 a share in 2010. At the June 10 closing price of $19.05, the stock traded at 11.91 times 2010 earnings per share. Analysts project that earnings will grow by an average rate of 9.6% a year over the next five years. That means the stock traded June 10 at a PEG ratio of 1.24. The price multiple is just 1.24 times the earnings growth rate.
An investor is paying about 20% less for Ita Unibanco's projected earnings growth over the next five years.
Of course, these calculations are only as good as the projections in them. But if anything, in my opinion these projections err in projecting too much growth for Wells Fargo and too little for Ita Unibanco:
The Brazilian economy is growing roughly two to three times faster than the United States'.
Brazil's credit rating is rising and that of the U.S. is likely falling.
The Brazilian real is appreciating, and the U.S. dollar is depreciating.
All these are reasons to suspect that the annual average 9.6% earnings growth rate for Ita Unibanco is underestimated.
My point, though, is that even without any adjustment to the Wall Street consensus, Ita Unibanco is projected to deliver more earnings growth for your investing buck.
(An aside to investors trying to decide when to get into a market such as Brazil: Peter Lynch, the great mutual fund manager, long advocated buying growth stocks when their PEG ratios were 1 or less. At a price of $15.60, Ita Unibanco shows a PEG ratio of 1. I'm not saying you should wait for that price. I'm just saying . . .) by Jim Jubak, MSN Money.
