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Faster growth and cheaper too--what's not to like in emerging market stocks?
06/15/2010 8:30 am EST
But you don’t need to buy into the top down 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 that 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 macro reasons 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% GDP growth this year; India could come at 8% or above and Brazil seems headed for better than 7% versus a projected 1.2% for the European Union and somewhere between 2.5% and 3.5%for the United States.
Banking systems in most of the emerging economies are in better shape than in the developed world. The sub-prime 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 GDP or more. (Got to be careful here how you do your accounting though. You can make a case, and I have, that China is broke. See my post http://jubakpicks.com/2010/03/12/despite-those-huge-reserves-china-could-be-gasp-broke/ )
Developing countries are by and large younger than developed countries. That’s a big plus for long-term growth but it also means that the burden of paying for retirement and healthcare for an ever larger population of oldsters is further down the road for countries like India and Brazil. (For more on the long-range effects of these costs see my post http://jubakpicks.com/2010/05/25/get-used-to-it-the-global-debt-crisis-will-play-out-over-and-over-again-in-the-next-decades/ )
Now the micro.
I don’t want to argue the macro micro here. It’s just too hard to figure out what a reasonable market multiple is for emerging economy stocks. The Shanghai Composite index, for example, is trading at about 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) the fourth largest U.S. bank by assets at the end of the first quarter of 2010 and a Brazilian bank, Itau Unibanco (ITUB), the largest bank by assets in Brazil.
A share of Wells Fargo went for $28.13 at the close on June 10, 2010. With 5.2 billion shares outstanding the market cap was $147 billion.
Itau’s New York Stock Exchange-traded ADR 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 ratio and the earnings growth rates and particularly at a ratio between the price-to-earnings ratio and the earnings growth rate called the PEG ratio.
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 14.27 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 on June 10 at a PEG ratio of 1.52. (That’s the forward PE divided by the average annual growth rate.) The price multiple is 1.52 times the earnings growth rate.
Do the same analysis for Itau 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 on 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 (18.4% to be exact) for Itau Unibanco’s projected earnings growth over the next five years.
Of course, these calculations are only as good as the projections in them. (I used Wall Street consensus projections from MSN Money, Yahoo Finance, Bloomberg, and Thomson Reuters to come up with the figures I used.) But if anything, in my opinion these projections err in projecting too much growth for Wells Fargo and too little for Itau Unibanco. The Brazilian economy is growing roughly three times faster, 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 Banco Itau is underestimated.
My point, though, is that even without any adjustment to the Wall Street consensus, Itau Unibanco is projected to deliver more earnings growth for your investing buck.
(As 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 ratio was one or less. At a price of $15.60 Itau Unibanco shows a PEG ratio of 1. I’m not saying you should wait for that price. I’m just saying….)
Itau Unibanco has been in Jim’s Watch List http://jubakpicks.com/ since December 17, 2009. The shares have dropped 11.7% from that date through June 10.
In some comparisons the emerging market stock is so much cheaper, even using growth estimates you think ridiculously low, that you’re buying a whole lot of upside for nothing—if it turns out that your growth estimate and not Wall Street’s is accurate.
Compare two steel companies, for example. Brazil’s Gerdau (GGB) sold for $13.60 a share on June 10. Wall Street projected 2010 earnings per share at $1.66 for a projected price-to-earnings ratio of 8.12. Wall Street projects Gerdau’s average annual earnings growth at just 6% over the next five years. I think that’s ridiculously low for a developing country projected to grow by 7% in 2010, but no matter: Even with the low Wall Street earnings growth estimate the PEG ratio comes to 1.36. (I added Gerdau to my watch list in my post http://jubakpicks.com/2010/06/11/the-next-rally-wont-be-like-the-last-one-heres-how-to-make-sure-you-find-the-next-leaders/ .)
Nucor (NUE), to my mind the best U.S. steel company, sold for $42.43 on June 10. 2010 earnings are projected at $1.62 a share for a forward price-to-earnings ratio of 26.19. Wall Street estimates average annual earnings growth of 15% over the next five years. That works out to a PEG ratio of 1.75.
You’ll notice that I’ve been picking pretty good developed economy companies to use in my comparisons. That’s important. You want to find the developing market stocks that can beat the best that the developing markets have. We’re not trying to find mediocre emerging market stocks that can beat really crummy developed market stocks.
So don’t be afraid. Go for it and put those emerging market stocks up against the best.
How does Petrochina (PTR), for example, measure up against ExxonMobil (XOM)?
According to Wall Street projections Petrochina will produce earnings per share of $12.80 in 2010. With the June 10 closing price at $111.765 that’s a forward price-to-earnings ratio of 8.73. Wall Street says Petrochina will show earnings growth of 5.7% a year on average over the next five years. That’s a PEG ratio of 1.53.
ExxonMobil is projected to grow 2010 earnings to $5.76 a share. On the June 10 price of $61.89 that’s a forward price to earnings ratio of 10.59. Average annual earnings growth over the next five years is projected at 8.63%. That’s a PEG ratio of 1.23.
ExxonMobil comes out on top in this comparison. Buy that developed economy oil company if you want the most earnings growth for your buck.
But the contest was closer than I thought it would be. And it tells you something when the best managed, most profitable oil company in the developed world doesn’t run away without breaking a sweat from one of the developing world’s best.
The message isn’t some depressing decline of the developed world drama, however.
Just a reminder that as an investor today you can’t take anything for granted. At least not if your goal is to make a buck.
Full disclosure: I own shares of Nucor in my personal portfolio.
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