For Great Returns, Ignore the Western Headlines

 | Oct 11, 2011 | 1:22 PM EDT  | Comments
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Stock quotes in this article:

hogs

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feed

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pkx

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VWO

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EWY

While most investors are fixated on political and economic gyrations in Europe and the U.S., markets like China and South Korea are trading at historically low valuations despite the fact that their economies will continue showing stable growth for the foreseeable future. Investors looking for portfolio performance may want to ignore the headlines and look to emerging markets for results.

The MSCI Emerging Market Index, as tracked by the Vanguard MSCI Emerging Markets ETF (VWO), is down more than 25% year to date and trades at a price-to-earnings multiple of 11x. This plunge seemingly ignores the fact that, after growing by more than 10% in 2010, China -- VWO's biggest country by allocation -- is expected to grow its GDP by 9.5% and 9% in 2011 and 2012, respectively, according to the IMF. That GDP growth plus a positive trade surplus provide a solid foundation for long-term economic upside and value creation in China.

The iShares South Korea Index (EWY) is down more than 24% year to date and trades at an average P/E of 9x; the IMF is looking for real GDP growth of 3.9% and 4.5% in 2011 and 2012, respectively. The data from other emerging nations shows similar numbers -- quality growth at discount valuation.

The above ETFs and others like them are suitable for investors looking for a broad way to play a particular country or the emerging markets in general. Individual stocks may also provide additional upside due to company-specific characteristics (and notwithstanding the company-specific risks). Small-cap Zhongpin (HOGS) is a potential play on the basic food needs of the Chinese, specifically pork, which China consumes more of than any other nation. Zhongpin is of one mainland China's leading pork processors and distributors.

There is very little enthusiasm for U.S.-listed Chinese companies these days, as many have been accused of fraudulent activities. Few companies have been spared their turn in the hot seat; indeed, several market participants have questioned Zhongpin's past results. Sales have grown from $30 million in 2003 to nearly $1 billion in 2010 while profits have grown from $1.5 million to nearly $60 million -- such growth rates would make any investor skeptical. The stock now trades for under $7, less than 4x earnings and well under book value per share of nearly $10. This valuation exists because of the investors' rampant distrust of U.S.-listed Chinese companies. Case in point: Smaller rival AgFeed Industries (FEED) recently announced that it was forming a special committee to investigate its own accounting practices related to Chinese farm operations. Either Zhongpin is doing a better job of hiding its problems, or it's a baby being thrown out with the bathwater. If it's the latter, the stock should easily trade north of $20 in a rational environment.

If you're looking for South Korean pick, Posco (PKX), one of the largest steelmakers in the world, has fallen from a high of $120 per ADR back to $82, valuing the company at 6.3x forward earnings. Posco has all the right pieces in place: quality management, good corporate governance and a low cost of production. It's a great value today; if shares fall below $70, it's an outright steal.

Emerging markets have sold off indiscriminately due to concerns in Europe and the U.S. But the emerging nations are only in the beginning innings of a long-term growth story that will pay off handsomely for investors looking to place some long-term bets.

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