Hunting for value in emerging-market funds

Many emerging-market stocks look cheap – but few funds are betting on them while the risks remain high

One of the headaches of buying out-of-favour assets is that the more out of favour they become, the harder it gets to invest in them. Take cheap emerging market shares. Ever since the rally began in April, emerging markets have polarised between a small number of hot stocks, mostly in the tech sector, and a large pack of also-rans. The same is true in developed markets, of course; Alphabet, Apple, Amazon, Facebook, Microsoft and their peers have soared ahead since April. Yet the gulf in emerging markets is even wider. 

The MSCI Emerging Markets Growth Index now trades on a price/earnings ratio of 24 times forecast earnings, while the MSCI Emerging Markets Value Index is on 10.5. These way these indexes are constructed isn’t perfect (somehow Samsung Electronics – which I would say is more growth than value – manages to appear in both), but you get similar results if you try to look at the divide in other ways.

Where are the value managers?

Given that, you’d expect at least some emerging-market managers to be taking the risk of loading up on value. After all, even though tech is leading the way in developed markets, you can still find die-hard value managers preaching the merits of financials, energy or other depressed sectors. Not so in emerging markets. Finding a broad fund that doesn’t have Alibaba, Tencent, Taiwan Semiconductor Manufacturing, Samsung Electronics and so on as its largest holdings is surprisingly difficult. That’s partly because these firms have performed so well that a modest starting position is now a large one – and few managers will be keen to take the risk of selling winners like these to buy beaten-down losers. And yet when valuations are this far apart, the argument for committing part of a portfolio to risky stocks is at its strongest.

So where can investors look if they want to buy value? One option is to pick cheap countries. Investors are disillusioned with Southeast Asia, but they are outright despondent about Brazil and they don’t much like Russia. So exchange-traded funds such as iShares MSCI Brazil (LSE: IBZL) and HSBC MSCI Russia Capped (LSE: HRUB) could be worth a look. The fate of both will depend on a rebound in energy and commodities. Alternatively, look for unloved investment trusts on wide discounts to net asset value. ScotGems (LSE: SGEM), which invests in emerging-market smaller companies, has done badly since floating in 2017. Its portfolio is down 25% over the past year. Yet the quality of its holdings looks okay; at least part of its problems is due to being heavily weighted towards markets that have struggled. A discount of 24% should narrow if those countries stage a recovery. 

I wish I knew what a price/sales ratio was, but I’m too embarrassed to ask

The price/sales (p/s) ratio is a method for valuing a company, similar to other metrics such as the price/earnings (p/e) ratio and the price/book (p/b) ratio. A firm’s p/s ratio is usually calculated by dividing its market capitalisation by its revenues. So a company with a market cap of £25bn and sales of £10bn has a p/s ratio of 2.5. 

You’d get exactly the same result if you divided the share price by revenues per share. But unlike earnings or book value, revenues aren’t usually reported on a per share basis, so using total sales means one less step in the calculation.

Just like a p/e ratio, a low p/s ratio may imply a cheap stock. However, sales aren’t the same as profits, so the p/s ratio requires even more care when deciding if a stock is cheap.

Different sectors have very different profit margins, so the p/s ratio is most useful when comparing companies within the same sector. It can be especially helpful when looking at firms whose earnings are temporarily depressed as a result of one-off factors, but which should later return to a more normal level. This is often the case in cyclical industries. 

The p/s ratio can also be useful when comparing early-stage growth stocks against their peers. These firms may be growing rapidly, but not yet making a profit, rendering the p/e ratio useless. The p/s ratio tells you how much the market is paying for each pound of sales. Of course, the value of this depends on whether your assumptions about a firm’s future profitability are realistic: a business with little prospect of making a profit will be a bad investment even if the p/s ratio is low. 

The p/s ratio does not take debt into account. This means that when one firm has more debt than an otherwise identical rival, it will look cheaper (but may well be riskier). To get a picture that includes debt, use enterprise value (equity market capitalisation plus the value of outstanding debt) divided by sales instead.

Recommended

Should you defer your pension and stay in work?
Pensions

Should you defer your pension and stay in work?

The pros and cons of deferring your pension and staying in employment beyond 66 are finely balanced.
15 Sep 2021
The UK jobs market is booming – what does that mean for investors?
UK Economy

The UK jobs market is booming – what does that mean for investors?

Unemployment in the UK is back to pre-pandemic levels, employers are desperate to hire more staff, and wages are rising. John Stepek looks at what tha…
14 Sep 2021
Royal Mail will deliver for investors – here's how to play it
Trading

Royal Mail will deliver for investors – here's how to play it

Royal Mail Group has found its feet in the past 18 months and looks cheap. Matthew Partridge looks at how to trade the shares.
14 Sep 2021
How to stop recurring subscriptions becoming a drain on your money
Personal finance

How to stop recurring subscriptions becoming a drain on your money

Tracking and pruning subscriptions isn’t as easy as it sounds. Here's how to take charge.
14 Sep 2021

Most Popular

Should investors be worried about stagflation?
US Economy

Should investors be worried about stagflation?

The latest US employment data has raised the ugly spectre of “stagflation” – weak growth and high inflation. John Stepek looks at what’s going on and …
6 Sep 2021
Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
How you can profit from the power of the grey pound
Share tips

How you can profit from the power of the grey pound

Higher life expectancy and surging asset prices have proved a boon for the baby-boomer generation, which has accumulated vast wealth. Younger generati…
10 Sep 2021