The Best Places for Growth

Emerging-market stocks have had a rough start to 2007, led by news of political and economic instability in Thailand. Bomb explosions in Bangkok, government-imposed restrictions on foreign investments, and threats of yet another military coup plague the region's economic outlook.

We shouldn't be entirely shocked by the events in Thailand. After all, there have been 18 military coups in the country since the absolute monarchy was abolished in 1932.

That's roughly one coup every four years -- not exactly the best environment for promising companies to realize their potential.

Risky business
In the past few years, emerging-market stocks have been touted as the best places for growth. Indeed, this has been an accurate observation. The Vanguard Emerging Markets Index Fund, for instance, which is buoyed by the likes of China Mobile (NYSE: CHL), Petrobras (NYSE: PBR), and America Movil (NYSE: AMX), has averaged 26% per year over the past five years.

Compare those returns to the blue-chip-laden S&P 500, which notched 6% annualized gains over that time, and you can see why investors were flocking to the emerging markets. The weakness of traditionally strong U.S. firms like General Electric (NYSE: GE) and AT&T (NYSE: T) was simply uninspiring to many investors during this period.

But perhaps these stellar emerging-market returns have blinded us to the fact that not all markets are created equal.

Doomed to repeat it
It's important for investors to understand the history and current state of their stocks' home countries before investing and adjust risk-return expectations accordingly.

If you're invested in South Korean companies such as POSCO (NYSE: PKX) or KookminBank, for example, it would behoove you to keep an eye on the volatile political relationship with North Korea. Indeed, the broader iSharesMSCI South Korea (NYSE: EWY) ETF lost 5% during the tense period in October 2006, when North Korea claimed to have tested a nuclear device. The ETF has rebounded from its autumn lows, but a protracted conflict in the region could significantly affect long-term returns of South Korean stocks.

Other emerging-market economic crises in the past 10 years, such as the currency debacles in Latin America and Asia in the 1990s, hurt emerging-market stock returns. In fact, the Vanguard Emerging Markets Index Fund lost 19% in 1997 and 21% in 1998.

Needless to say, these stocks are not for the faint of heart.

For taking on the added risks of emerging-market stocks, you should likewise expect more in return. Otherwise, you'd be better off investing in companies hailing from more developed economies where there's substantially less political and economic risk.

Foolish bottom line
Look, there are always going to be added risks when you invest overseas. It would be easy to simply invest in tried-and-true domestic stocks, but by doing so, you also risk missing out on some great growth opportunities in other countries.

The secret to finding the best foreign stocks is finding quality companies in countries that promote free markets and encourage foreign investment. These are exactly the kinds of companies our Motley Fool Global Gains international investing service looks for.

If you're interested in reading about the foreign stocks our team has recommended, consider a free, full-access 30-day trial to the service. There's no obligation to subscribe.

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Todd Wenning does not own shares of any company mentioned. POSCO is a Motley Fool Income Investor pick. AT&T is a former Stock Advisor pick. The Fool is investors writing for investors.