Don’t let Unilever put you off – emerging markets are still worth buying

Unilever has had a rotten week.

The consumer giant rarely gives forecasts, but this week it had to confess that things aren't going as well as usual. It now reckons that sales will only grow by 3% in the current quarter. That's down from 5% earlier this year.

Given that more than half of Unilever's sales are in emerging markets, you could see the news as a big sell' signal for countries outside Europe and North America.

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But that would be a mistake. Here's why

There are good reasons to be concerned about emerging markets

quantitative easing (QE)

You see, all that printed money has to go somewhere, and emerging markets were one of the key beneficiaries. Fears that Fed chief Ben Bernanke would rein in or taper' QE saw many investors rush to bring their money back home' to the US. The Indian rupee and the Brazilian real were particular casualties of this panic.

That slide has been tempered by the Fed's decision to keep QE going at full blast for a while longer. But clearly, there's still the potential for further taper tantrums' in the months ahead.

The second argument against emerging markets revolves around China. Yes, we're starting to see signs of a rebound in Chinese growth just now, which will no doubt help sentiment towards emerging markets in general.

But the longer-term challenge for China is it needs to go from being an investment-led economy to one that primarily serves domestic consumers. Put simply, China can't just rely on exports and building ghost cities' to generate growth anymore. So its consumers need to start spending more.

However, making that shift is far easier said than done. It's a stage at which many developing markets have faltered in the past, and even if the transition is eventually successful, it's unlikely to be smooth running all the way.

But a lot of the bad news is in the price

If you look at the price/book ratio, for example, emerging market shares have gone from trading at a 15% premium to developed world stocks in 2010 to a 30% discount now, according to Pictet Asset Management. In short, emerging market stocks look cheap compared to the assets the companies hold on their balance sheets.

Price/earnings ratios have also fallen to historically cheap levels in many markets, particularly if you look at the cyclically-adjusted price/earnings ratio (this looks at average earnings over ten years, which helps to smooth out the ups and downs of the business cycle).

Then there's the issue of corporate governance. This has always rightly been a bugbear of investors in emerging markets. But we're seeing gradual improvements in several countries. Perhaps the most striking change has been in Russia, where the government now insists that all state-owned companies must pay out at least 25% of profits in dividends.

This in turn is putting pressure on some private sector Russian companies to increase their dividend payouts in response.

Don't get me wrong - I'm not suggesting that Russia is now an ultra-safe market. Not with President Vladimir Putin's track record for renegotiating' deals with Western companies such as BP.

But often, the best time to invest in any market is when things are just starting to get better, not when the turnaround is in full swing. The point is, there are some small signs of concrete governance improvements, and not just in Russia.

It's also worth noting that the currency falls this summer were helpful to many emerging markets, as they meant these countries could sell their exports more cheaply.

How to invest

Another option is to go for one of the big generalist investment trusts such as the Templeton Emerging Markets (LSE: TEM) investment trust or JP Morgan Emerging Markets Investment Trust (LSE: JMG). The first trades on a discount of around 7%, and is most heavily exposed to Hong Kong, Thailand and Brazil. The JPM trust is on a discount of almost 9%, and has significant sums in Brazil, India, South Africa and Hong Kong.

Or you could take more risk and invest in a fund that is focused on one particular country. We've looked at ways to play Brazil and Russia in recent issues of MoneyWeek magazine. And in this week's edition, out today, we look at how to play a particularly promising emerging market Vietnam. If you're not already a subscriber, subscribe to MoneyWeek magazine.

And if you are interested in investing in individual emerging markets, I'd suggest you sign up for my colleague Lars Henriksson's The New World email it's free, and full of useful advice on the developing world.

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