Global Investing

Value or growth? The dichotomy of emerging market shares

Investors in emerging markets are facing a tough choice. Should one buy cheap shares in the hope that poor corporate governance and profitability will improve some day? Or is it better to close one’s eyes and buy into expensively valued companies that sell mobile telephones, holidays and handbags — all the things high-spending emerging market consumers hanker after?

At the moment, investors are plumping for the latter, growth-at-any price investment strategy. Result: a lopsided emerging equity index in which consumer discretionary shares are up more than 5 percent this year, energy shares have lost 7 percent while MSCI’s benchmark emerging equity index is down 3 percent.

All markets have their share of cheap and expensive. But the dichotomy in emerging markets is especially stark. Analysis by Bank of America/Merrill Lynch of the biggest 100 emerging market companies revealed last week that the 20 most expensive stocks in this bucket are trading 11 times book value and 31 times earnings (both on trailing basis) while forward earnings-per-share (EPS) is seen at almost 30 percent. The top-20 companies all belong to the private sector and most are in the consumer-facing industries.  This year they have gained more than 50 percent.

Meanwhile the bottom 20 companies in the top-100 are mostly state owned enterprises and they come from the “old economy” — banks, energy and materials. They are also cheap, trading less than 1 time book value and around 8 times trailing earnings. BofA/ML equity strategist Ajay Kapur writes:

So the key differential in the big 100 in emerging markets is between fast growing expensive private sector firms and sluggish generally state-owned cheap laggards.

Can Eastern Europe “sweat” it?

Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.

Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.

Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.