Emerging-market stocks have vastly underperformed those in the U.S. and other developed markets in recent years.
The MSCI Emerging Markets Index has returned an annualized 1.71% over the past five years through July 31, compared to 12.2% for the S&P 500.
With long-term economic growth trends looking strong in emerging markets, now could be a good time to buy their stocks at a bargain. That’s the view of Henry Mallari-D’Auria, chief investment officer, emerging markets value, for money manager Ariel Investments.
He explained his bullishness toward emerging markets and his favorite industries and countries in a recent interview with TheStreet. He also offered several stock picks.
TheStreet: What’s your investment philosophy?
Mallari-D’Auria: Value investing, where we think there are catalysts to what we see. That’s something in the country, industry or company that leads people to change their mind about the stock.
TheStreet: What’s the appeal of emerging market stocks?
Mallari-D’Auria: Today in particular offers exposure to cyclical and secular growth. Many emerging market countries came out of covid later than developed countries. And some countries like China are easing [economic] policy when developed markets are tightening.
Cyclically, earnings growth in emerging markets is likely to exceed growth in developed markets. Also, valuations in emerging markets are near historical lows.
The MSCI Emerging Markets Index trades at about 11 times 2023 earnings. [The forward price-earnings ratio for the S&P 500 was 19.2 as of Aug. 4] This is one of the best times to invest in emerging market companies.
TheStreet: What geographies are most appealing now?
Mallari-D’Auria: Some of the best secular growth trends are in Vietnam and the Philippines. They have low valuations and cyclical rebounds. Real economic growth of 6% to 7% is expected in both countries. They have growing populations and productivity. They will take share, as China loses competitiveness in more labor intensive industries, due to higher Chinese wages.
Vietnam benefits from [the manufacturing sector] moving from China to lower-cost countries. And as the economy expands, we’ll see income rise for consumers.
The Philippines is a similar story. It’s taking share in services, such as business-process outsourcing. For example, companies like JPMorgan Chase have shifted call centers to the country. JPMorgan has 18,000 employees based in the Philippines. You can buy many stocks with 15%-20% revenue growth at low double-digit price-earnings ratios.
TheStreet: What industries do you find most appealing now?
Mallari-D’Auria: The memory industry [the largest category of semiconductors]. The price of memory will rise as the supply-demand equation improves.
Current memory prices are quite low, causing the industry to reduce growth in capacity. That’s happening at the same time that demand is accelerating, as hyperscalers like Google are increasing spending on servers as they pursue artificial intelligence.
We expect an increase in memory prices next year. That will benefit SK Hynix of South Korea, our single largest holding.
TheStreet: Can you tell us three of your favorite stocks?
1. Alibaba (BABA) - Get Free Report. As the world’s leading e-commerce company, it’s likely to benefit from accelerating growth out of covid. It will also benefit from its focus on controlling costs in its non-core businesses.
Shareholders should benefit from the spinoff of its cloud business. Alibaba is trading at 10 times forecast 2023 earnings. That understates its growth, particularly as we see Chinese consumers accelerating their purchases into 2024.
2. State Bank of India (SBKFF) - Get Free Report. It’s the leading bank in India and one of the fastest growing in emerging markets. Its loan penetration is still low. Given its higher profitability than most of the industry, it should be able to take share in this fast growth environment.
To keep pace, the company will have to raise equity. But the attractiveness of additional loans is high enough that raising capital will benefit earnings per share. At 9 times earnings, it’s one of the most attractive ways to play long-term growth in the Indian economy.
3. Taiwan Semiconductor Manufacturing (TSM) - Get Free Report. It’s the world’s leading foundry [contracting company for semiconductor manufacturing]. Foundries as a business model continue to take share. That’s because there’s a need for faster computing speeds best done by specialists like TSM.
It will benefit from more investment in high-end servers for artificial intelligence. And there will likely be a cyclical rebound in traditional semiconductor demand. That’s true for personal computer makers and mobile phone makers, as inventories of phones have been drawn down.
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This story was originally published August 13, 2023, 7:00 AM.