| Mitchell Posner is President of Kirkwood Financial, Inc., an advisory firm to financial institutions around the world, providing equity research on emerging market companies and industries in South America, Africa, Europe and Asia. Selecting emerging market stocks From PROFITING FROM EMERGING MARKET STOCKS by Mitchell Posner copyright 1998 Reprinted with permission of Learning Network Direct, a part of the Learning Network. Introduction Any investor with experience in picking U.S. or European stocks can, in theory, pick emerging market stocks, because stock screening and selection methods should work anywhere . In practice, fundamental techniques of securities analysis require adjustment for the special conditions in emerging markets. -
Choose performance and valuation measures according to the market you are studying . Unless there is a specific reason to screen for price-earnings ratios, price-book value, price-sales and price-cash flow, you needn't track each one. They will usually list the same types of stocks. Favor the most reliable data for the particular market. For example, in countries where book values are suspect, you might be better served by price-sales. In countries such as India and Malaysia, where strict American-style accounting practices apply, financial statement analysis is more worthwhile for screening. Market share is often a good benchmark. Well-managed companies tend to consolidate and increase market share when the economy expands. -
Recognise the limitations of some traditional screening criteria. Screen for both high-growth and high-dividend payout , and you won't have many stocks to choose from. It's like demanding fuel economy from a high-performance sports car: they just don't go together. Many fast-growing emerging market companies have limited access to financing and reinvest their profits rather than pay dividends . Similarly, while P/E ratios enable you to make a rough approximation of a projected return on investment, they work best in situations that are slow and steady. And emerging market companies are anything but. So emerging market investors tend to pay less attention to P/Es as a measure of overpriced shares. Local factors affect the P/E ratio. For example, accelerated depreciation can depress earnings, making the P/Es appear high relative to a similar company, because the local market adjusts for that depreciation. -
Pay attention to company size . Consider the size of a company from several perspectives: its ranking in the local stock market; in its sector; on the global scene. Some emerging market stocks, such as Argentina's YPF and Russia's Lukoil, are among the world's largest companies. Picking one of the 'ten largest' in a market is a mixed blessing. You gain liquidity, and usually greater disclosure, and the benefit of available institutional research. Such stocks are usually at the high end of the valuation scale, however. There aren't likely to be any bargains here. So there had better be significant growth in the company's future to justify the high price. -
Treat liquidity as a primary consideration. Emerging market share prices are often determined not by rigid financial measures, but simply by how much investors are willing to pay and how much money is available. You can pay very little for a stock, or you can pay a great deal, but you can't ignore market sentiment. That sentiment is best measured by how much capital is flowing in and flowing out, and who is buying or not buying. Local savings rates, the availability of pension fund investments, and the lifting of restrictions on foreign ownership also play a role in a foreign stock's liquidity. -
Check financial strength, but make allowances. Size counts, but financial strength counts more. Examine the standard financial ratios and pay close attention to a deteriorating balance sheet or potential bankruptcies. While there are many excellent managers in emerging market nations, there is less depth, and it is easy for a once- healthy company to go into a tailspin. Nevertheless, don't set the bar too high. As financially -weakened emerging market companies tend to be heavily discounted by the market, you might find some bargains in potential turnarounds or acquisition targets. -
Be careful not to pick low volatility and end up with low liquidity. An emerging market stock with lower volatility than the overall market might seem like a more conservative buy. However, its lack of fluctuation could be a sign that the stock is quiet and liquidity is very low. -
Don't rely solely on brokerage reports . There are often conflicts of interest between research and investment banking departments. Aggressive investment bankers seeking new business and the chance to manage privatizations sometimes put pressure on research departments to avoid critical reports. Much of the available research is in the 'top ten' stocks. Don't expect the same depth and insight you are accustomed to finding in U.S. and European markets. Stocks followed by fewer than eight analysts are called 'underfollowed stocks' and they offer the greatest opportunities. Fewer institutions are likely to participate. While this may add to volatility and lower valuations it also creates opportunity. -
Get your portfolio balance right. A common mistake in emerging markets investing is getting the stock picks right but the portfolio wrong. If strict application of your stock screens generates a list that is 75 percent Mexican, adjust your criteria to allow more diversification. A single-country bet is generally unwise over the long term . -
Don't place too much reliance on technical analysis. Certain technical indicators, such as relative strength, may be useful in emerging markets, but for the most part there is not enough reliable historical data for proper technical analysis. Technical analysis may have its day in emerging markets, but that day has not yet arrived. -
Do not act impulsively on rumors. Emerging markets move on rumors such as the pending resignation of a finance minister, a corruption scandal, local resistance to privatization , and so forth. If you are interested in emerging markets and have money in them, you won't be able to ignore these rumors. They will find you. However, do not be impulsive. Acting on rumors is often expensive. www.kirkwoodgroup.net 'Don't pay active management fees for passive management by buying closet index funds.' ”Joe Mansueto |  |
