How to Evaluate Stocks in Developing Markets

Jim Jubak MSN Money June 15, 2010

You probably know the big reasons developing economies are growing. Here's how to tell when to favor emerging-market stocks over their developed-world counterparts.

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.

Where economies are growing fastest

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.Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 300, 213, {"configCsid": "MSNmoney", "configName": "player-money-articles-16x9", "player.vcq": "videoByUuids.aspx?uuids=b79d2109-45cb-4cd0-a934-519e1cb1f06c,d8c26de9-c23f-4e93-99e3-35fda7f11faa,bbcba8e1-be25-4dc7-8d8e-9481ebfa041a,db78d92a-e68c-4a5b-b529-dce51bec2010,62eafa99-a1d4-4dd5-a97f-a49c77ff953a,2e8693b6-1223-42bf-8ff1-1998aa78a8af,493db1c1-cb2d-42c2-bd5e-82bcdb5d0edf,f20a3a65-9b5e-4adb-9080-2c06d9c5e9a4,56051416-771a-4852-a0a9-edf54f071339,b2160e9d-1592-4d50-a1a8-780111ae1840,857ab02d-8fce-418b-bbcd-9da72fae40c6,448868e9-a84a-467b-b386-ca158ee40a96,3a357222-bc32-4439-8bc3-97ffb389f1ae,f9115343-6344-4006-8929-a97b40a6b2f2,1d54d2c5-3a87-4d6e-9385-7b294a5a935c", "player.fr": "iv2_en-us_money_article_16x9-Investing-JubaksJournal"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=b79d2109-45cb-4cd0-a934-519e1cb1f06c,d8c26de9-c23f-4e93-99e3-35fda7f11faa,bbcba8e1-be25-4dc7-8d8e-9481ebfa041a,db78d92a-e68c-4a5b-b529-dce51bec2010,62eafa99-a1d4-4dd5-a97f-a49c77ff953a,2e8693b6-1223-42bf-8ff1-1998aa78a8af,493db1c1-cb2d-42c2-bd5e-82bcdb5d0edf,f20a3a65-9b5e-4adb-9080-2c06d9c5e9a4,56051416-771a-4852-a0a9-edf54f071339,b2160e9d-1592-4d50-a1a8-780111ae1840,857ab02d-8fce-418b-bbcd-9da72fae40c6,448868e9-a84a-467b-b386-ca158ee40a96,3a357222-bc32-4439-8bc3-97ffb389f1ae,f9115343-6344-4006-8929-a97b40a6b2f2,1d54d2c5-3a87-4d6e-9385-7b294a5a935c;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');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.Growth at a more reasonable price Now the micro.

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, Itaú 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.

Itaú'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 Itaú 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 Itaú 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 Itaú 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 Itaú Unibanco is underestimated.

My point, though, is that even without any adjustment to the Wall Street consensus, Itaú 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, Itaú Unibanco shows a PEG ratio of 1. I'm not saying you should wait for that price. I'm just saying . . .)

Itaú Unibanco has been in Jim's Watch List since Dec. 17. The shares dropped 11.7% between then and June 10.

Continued: Measuring up More from MSN Money and MoneyShow.com

China's Ponzi-like banking policy

Jubak on video: Do job numbers worry the Fed?

Time for investors to watch and wait

Jubak on video: Singing Brazil's praises

China's dangerous balancing act

Revisiting the controversial views of Ayn Rand

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Have you upped your emerging market allocation given the turmoil in developed markets?

I'm conducting research of how the stock market's volatility has impacted the asset mix of household investment portfolios over the past two years. The link below will take you to a brief survey. Once you have completed the survey, you will see a graphic of the average investor allocation at 3/31/2010.

survey

Thanks to the 500+ respondents that have completed the survey so far. Some interesting tidbits...

1. A plurality of respondents report having an above average willingness to take investment risk.

2. Less than half of respondents were net purchasers of equity over the past year.

Please note: none of the questions ask for identifying information (e.g., name, social security #s, bank/brokerage accounts #s)

ReplyReport AbuseLost Dollar #2Tuesday, June 15, 2010 8:32:11 AMThe best time to buy in Emerging Markets is when you can still Brow Beat the Labor Market and treat them like Rented Mules. The Dynamics change when the Labor Market in that Emerging Market retaliates against the Status Quo and says, "No More". However, this will be short lived as Corporate will pull that Business out of one Emerging Market and plop it right into another Emerging Market unsuspecting that they will be the next Waive for Rented Mules. Vicious Cycles, but that is the New Global Economy.....Welcome Home!ReplyReport Abuse1 - 2 of 2PreviousNext_ucf13('0'); _iuc2Om1('MSNPortalInlineComments','Initial_Load_Comment_View','http://articles.moneycentral.msn.com/Investing/JubaksJournal/when-to-buy-emerging-market-stocks.aspx?page=2&','en-us');Are you sure you want to delete this comment?Report AbusePlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease notify us using the Report abuse form below. We will investigate your report and take appropriate action against offenders. We report all illegal activity to authorities.CategoriesSpam or advertisingChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatOtherAdditional comments(optional)100 character limit To add a comment, pleasesign in/*MSN PrivacyLegalAdvertiseRSSHelpFeedbackSite mapAbout our ads© 2010 Microsoft/*