The Best Buys in Brazil

They scare the crap out of you in Brazil.

Whether you want to sit on the Copacabana in Rio, take a walking tour of Sao Paulo, or buy a stock on Bovespa, people are going to tell you not to. That's because, these people say, you're likely to get drugged and robbed, have your arm cut off for your watch, or pay way too much for growth.

After you hear these warnings enough, they get into your head and become gospel. During our Motley Fool Global Gains research trip to Rio last month, I wouldn't leave the hotel after dark, and I spent much of the time after our meetings sitting poolside on the roof of our hotel.

No, I didn't see as much of Rio as I wanted to ... but I did get home alive.

Sky-high stocks are scary stocks
We had the privilege of meeting with a number of local investors during the trip. Some weren't invested in Brazil at all; others were 100% concentrated. What they shared, however, was a common fear for current valuations.

A recent paper by economist Paulo Esteves describes just how bad it's gotten. Recent IPOs on the Sao Paulo exchange were trading for an average of 7.4 times sales, 73.4 times earnings, and 29.7 times book at the end of 2007.

To put that in perspective, the S&P 500 currently trades at 1.5 times sales, 16.7 times earnings, and 2.7 times book.

Ask yourself: Is Brazil such a "sure thing" that you're willing to pay that kind of premium?

A better way
If you did, then you'd have been scorched these past two days as Brazilian stocks tumbled more than 5%. Many of the Brazilian investors we met with, however, have probably done quite well. When we talked with them, they were short stocks that they found particularly overvalued.

Fortunately, the Brazilian market isn't all bad. Our research trip uncovered a number of promising ideas -- some of which Americans can invest in, some of which they can't. See, it's very difficult for individual American investors to trade stocks in Sao Paulo. In addition to a good idea, you'd need an account on the exchange, a man on the ground, and a tax ID number. Reps at Bovespa (the local stock exchange) told us it would probably cost several hundred thousand dollars and months of time to set these structures up.

You can do the math to see how much money you'd need to invest for it to be worthwhile.

That's unfortunate, because one of the ideas that was almost unanimously recommended to us was Natura Cosmeticos. The once fast-growing environmentally conscious cosmetics company has seen its stock price collapse in the wake of its high-profile IPO -- and now trades for just 15 times earnings. I also believe it has better growth prospects than industry peers Alberto-Culver (NYSE: ACV), Avon Products (NYSE: AVP), and Elizabeth Arden (Nasdaq: RDEN)

But Natura does not offer American depositary receipts.

You can even go high-tech
Then there was Universo Online, a Portuguese-language Internet portal that's experiencing rapid page-view growth as broadband access expands in Brazil. And there's lots of upside here -- according to the World Bank, broadband penetration in Brazil is not even 2%.

Despite this potential and its high profile, cash currently makes up 30% of this stock's market cap -- meaning you can get the operations for cheap. That's a far cry from what you'll own to pay other emerging-market Internet portals, such as Baidu.com.

But if you're reading this from the States, you can't buy this one, either.

Seriously, thanks for the useless updates
The takeaways here are clear:

1. Because of today's frighteningly high valuations, buying an index fund/exchange-traded fund that tracks the Brazilian market might be a bad idea.
2. There are but 32 Brazilian companies listed as ADRs on our major exchanges. Given the deep pockets of American institutional and retail investors, that number is sure to increase. Keep an eye out for Natura Cosmeticos and Universo Online -- they really are solid businesses worthy of a spot on your watch list. Maybe they'll be on a U.S. exchange sometime soon.

It's also worth noting that we've received a few emails from our friends in Brazil in the past week stating that the country's airlines -- TAM (NYSE: TAM) and GOL (NYSE: GOL), which do offer ADRs -- are looking cheap again. These two players are a duopoly and don't suffer from the same competitive strains that have made AMR (NYSE: AMR) and UAL (Nasdaq: UAUA) such volatile investments.

During our trip, we hit on a number of other ideas you can currently buy in the United States, including an undervalued petrochemical business and a burgeoning fast-food chain.

We've released that report to our Global Gains subscribers, as well as a tip on a back door into ownership of UOL.

If you're interested, you can get those recommendations by clicking here to join Global Gains today. There is no obligation to subscribe. Brazil may be a scary place, but it is a market with serious upside potential.

This article was first published on Dec. 13, 2007. It has been updated.

Tim Hanson does not own shares of any company mentioned. Baidu.com is a Motley Fool Rule Breakers recommendation. The Motley Fool's disclosure policy weeps for the demise of Corinthians.