Many global firms provide emerging-markets exposure with less risk, though sometimes stocks in developing regions offer great opportunities, says StockInvestor editor Matt Coffina.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Matt Coffina. He is editor of Morningstar StockInvestor. We're going to get his take on emerging-markets investing and also take a closer look at one of his favorite emerging-markets stocks.
Matt, thanks for joining me today.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: Let's talk a little bit about your general strategy when you're managing the portfolios in StockInvestor. Do you think that you need a certain exposure to emerging markets or want to allocate a certain percentage to emerging markets, or is it more on a firm-by-firm basis and you just take it as it comes?
Coffina: Our strategy is very much bottom-up. I'm only interested in emerging markets to the extent that they have companies that could be interesting for whatever reason: strong competitive advantage, a competitive position that's improving over time, an attractive valuation, or ideally a combination of all of these things.
I think investors in emerging markets need to be aware of a lot of risks that come with that, that you don't necessarily have to worry about in the U.S. or other developed markets. This would include things like inflation, currency changes, unstable political environments, corporate governance is often weaker than what we have in the U.S., and so on.
I'd say emerging markets have much higher attractiveness hurdles to overcome given that elevated risk. So for the most part, we don't invest very much directly in emerging markets. We only have one emerging-markets company right now between our two portfolios in the Tortoise and Hare. That said, I think you can get a lot of exposure to emerging markets through global companies that participate in these markets, even without investing directly in emerging-markets companies.
Glaser: You think that investing in those multinationals helps to mitigate some of those risks? They still are exposed to currency, they still are exposed to potential inflation risk, why are you less concerned about those risks there?
Coffina: Usually you don't have the same corporate governance issues for one thing. Often these are some of the highest-quality companies in the world, as well, and often they're diversified across markets. Some companies that we own--like Coca-Cola, Philip Morris International, both in the consumer space, a lot of the pharmaceutical companies like Novartis or Johnson & Johnson that we own in the Tortoise. Even if you get down to payment processors like MasterCard--over the long run, I think a lot of their growth is going to come from emerging markets.
To a certain extent, it's almost harder to identify companies that aren't exposed to emerging markets that we own. The vast majority of global companies are exposed to some extent. But for some of those companies that I just mentioned, like a Coca-Cola or a Philip Morris International, a lot of their growth is going to be coming from emerging markets. I see that as a safer way to get exposure to the relatively elevated economic growth rates that you'll see in some of these emerging markets.
<TRANSCRIPT>
Glaser: You do own one emerging-markets-domiciled stock. Can you tell us what that is and why you feel comfortable holding it?
Coffina: That would be Baidu. Baidu is basically the Chinese version of Google. It's their main Internet search engine, somewhere about 70% market share of search. That's a case where the stock was actually run up a lot this year, so it would be hard to recommend purchasing the stock at these levels. It's already at a meaningful premium to our fair value estimate. When we bought the stock it was at about half of the current level. We bought it from--20 times earnings was my initial purchase, and then we were able to buy for as little as 16 times earnings.
When you have a company growing 50% or so a year that you can buy for 16 and 20 times earnings, you have a significant margin of safety in the valuation there. Now, the stock is trading at more than 30 times earnings and that margin of safety just isn't there anymore.
That said, a company like Baidu I think has a very long runway for growth, and I'm certainly comfortable holding it now that we own it already. You could think of Baidu as Google's business model on overdrive. Google has a few secular tailwinds driving its growth: One would be overall growth in advertising spending; another would be the shift in advertising spending from traditional media to online channels. The third would be shifts within the online channel to more search-based advertising and other properties that Google owns like its video sites.
Baidu basically has the same trends working in its favor, but you can add to those increasing Internet penetration, where China already has largest Internet-using population in the world, but it's still a fairly small fraction of the overall population. I think it's inevitable that 10 or 20 or 30 years from now, a much larger percentage of the population in China is going to be on the Internet using smartphones, searching for information on sites like Baidu.
This is a company that I see as having a very, very long runway for growth, which offsets a lot of the risks that are involved, those same risks that we talked about. In Baidu's case, there is other company-specific and country-specific risk. For example, this company operates as a variable-interest entity, which means we don't have direct ownership of the assets in China. There are concerns like that that have to be overcome with attractive total-return prospects, which I think we had at the time of purchase, and I think we still have to continue holding. But investors buying today don't have that same margin of safety.
Glaser: Generally speaking then, you do see good growth in emerging markets, but it's probably better to tap that through multinationals unless you're finding a really compelling valuation in an emerging-markets-domiciled stock?
Coffina: Yes, I think that's a good way of summarizing my take is that we get plenty of emerging-markets exposures through some of these very high-quality global companies, and then, if there are specific opportunities that make sense in an emerging markets (and I'd say they're pretty few and far between, especially in my universe of companies, which would be more large-cap companies with wide and narrow economic moats, with U.S. listings is also an important factor for us because we want it to be easy to buy and sell these shares).
I'd say it's a very small universe of emerging-markets companies that we would be interested in. But every once in a while you have a great opportunity like Baidu come along and it's worth jumping in.
Glaser: Matt, thanks for your time today.
Coffina: Thanks for having me, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.
| StockInvestor Newsletter | ||
 | Want more wide-moat stock ideas from Morningstar? Subscribe to Morningstar StockInvestor, where Matt Coffina uses our robust data, research, and analysis to find the best wide- and expanding-moat stocks to own. | One-Year Digital Subscription 12 Issues | $125 Premium Members: $115 Easy Checkout |
