Everyone wants to buy stocks that will reward them with long streaks of big price gains. But if you wait until after a long bull run to buy a stock, you'll usually miss out on the lion's share of its gains -- and if you ignore valuation completely, then you could end up a big loser.
That's the scenario that's currently playing itself out in one of the hottest markets in the investing universe. As promising as the prospects are for these stocks, it makes no sense to buy them willy-nilly without paying attention to their true value.
Just can't get enough
Emerging markets have been a favorite among investors for years, and there's no sign that the trend will reverse itself anytime soon. With big moves higher for stocks in leading emerging nations like China and Brazil, exchange-traded funds that concentrate on emerging market stocks are gathering more assets by far than any other type of stock ETF available. According to figures from iShares cited by Barron's, almost 90% of inflows into stock funds is going into emerging-market ETFs.
Vanguard and iShares run the two largest ETFs tracking those markets. Both of them track the same benchmark: the MSCI Emerging Markets Index. With nearly $100 billion in assets between the two, there's a lot of money flowing into the same stocks -- with a particular concentration on the biggest stocks in those indexes.
Do they deserve so much money?
As it turns out, the ETFs don't have identical holdings. But put their investments side by side, and you'll find the same names appearing close to each other on both lists. In particular:
- Natural resources play a prominent role in the index. You'll find energy companies from three different countries in each ETF: Russia's Gazprom, Brazil's Petrobras (NYSE: PBR ) , and China's CNOOC (NYSE: CEO ) . Brazilian miner Vale (NYSE: VALE ) also appears on both lists.
- Mobile industry stocks also have big weightings, with China Mobile (NYSE: CHL ) and Mexico's America Movil (NYSE: AMX ) among top 10 holdings for both.
- Financial institutions are big players in the index. Stocks in the financial industry represent more than 20% of assets in each fund.
Index investing is an efficient way for individual investors to get exposure to a broader market. But when index products get too popular, they can distort the markets they aim to follow. So with investors essentially buying these stocks at any price, have they gotten too expensive?
A closer look
With telecom stocks, the answer appears to be no. Both China Mobile and America Movil trade at relatively sedate earnings multiples -- multiples that in fact are far below what you'll find at most U.S. mobile companies. Sure, you can find better deals among European telecoms, but they obviously have risks of their own.
Similarly, the oil and natural resources stocks in the MSCI Emerging Markets Index carry even more deeply discounted valuations right now. Some of the discounts come from macroeconomic worries about whether emerging economies will have to see their growth slow in the coming months and years. But with Petrobras having found huge potential reserves off the Brazilian coast and CNOOC seeking to gain expertise on shale-gas development by buying into overseas projects, these companies look similar to their developed-country peers -- and certainly don't trade at a premium to the reasonable valuations on the energy and materials stocks that you'll find worldwide.
Banks and financial institutions are harder to read because most of them don't have shares that trade on U.S. exchanges. Concerns about the relationship between Chinese banks and the national government raise some issues about whether investing in them is a smart move. And with dim sum bonds circumventing Chinese bank financing, the industry could face a shock in the coming years.
Holding its own
At least for now, emerging-market ETFs don't appear to be making huge mistakes with their stock choices. That doesn't mean that the ETFs are perfect; they likely have too little emphasis on consumer-oriented stocks that could be the growth drivers for emerging economies in the next phase of their development. But for investors seeking emerging-market exposure, it doesn't appear that heavy ETF demand has damaged the value proposition for their biggest component stocks.
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