3 Stock Ideas From an Emerging Powerhouse

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Right now, we are witnessing the dark side of globalization. The world is so interconnected that economies grow and contract at the same time. I used to be a fan of the idea that some emerging markets can "decouple" -- that is, keep growing even as the U.S. economy is in recession -- but the evidence I've seen so far does not support that view.

In an article last month, I detailed the things investors should look to avoid in emerging markets. Not included in the "emerging markets to avoid" category was a rather notable highflier of recent years: India.

Why India?
India is a democracy -- yes, it's a messy one, but do you know any that aren't? It has a highly educated workforce, and it's relatively less developed and leveraged than China. In other words: India has more potential. The benchmark Indian stock index -- a.k.a. the Sensex -- is down from a high of 21,200 at the beginning of 2008 to just over 9000 at last check, or nearly 58% lower. In January of last year, Indian stocks were expensive, trading at 31 times earnings. Now, at a multiple of close to 9, Indian stocks may be downright cheap. The same educated workforce is there, and India is lot less dependent on exports -- $175.7 billion in exports with a $1.237 trillion economy -- compared to China, which has exports of $1.465 trillion on a $4.22 trillion economy.

India is not immune to Enron- and Worldcom-type scandals -- recently Satyam (NYSE: SAY), a major computer services company, admitted to falsifying financial statements. But this type of fraud should be taken as a reminder that diversification and not taking management's word at face value are critically important to investing. Fraud is part of human nature and has been with us since the beginning of time. The United States -- the world's most developed market -- still sees it happen in figures like Bernard Madoff, so instances like what happened with Satyam should not discourage you from looking for opportunities in India.

How to do your own research
Bank of New York has a great portal that can help you do your own research on ADRs (www.bnyadr.com). You can narrow by countries and exchanges; as a rule of thumb, stick with listed ADRs, and be more careful with OTC-traded ones. There are 14 choices on the major U.S. exchanges, and I'll discuss my favorites below.

Company	Exchange	Industry
Dr. Reddy's Laboratories (NYSE: RDY)	NYSE	Pharma & Biotech
HDFC Bank (NYSE: HDB)	NYSE	Banks
ICICI Bank (NYSE: IBN)	NYSE	Banks
Infosys Technologies (Nasdaq: INFY)	Nasdaq	Software & Computer Serv.
Mahanagar Telephone Nigam	NYSE	Fixed Line Telecom
Patni Computer Systems	NYSE	Software & Computer Serv.
Rediff.com (Nasdaq: REDF)	Nasdaq	Software & Computer Serv.
Satyam Computer Services	NYSE	Software & Computer Serv.
SIFY	Nasdaq	Software & Computer Serv.
Sterlite Industries	NYSE	Indust. Metals & Mining
Tata Communications	NYSE	Fixed Line Telecom
Tata Motors (NYSE: TTM)	NYSE	Industrial Engineering
Wipro	NYSE	Software & Computer Serv.
WNS Holdings	NYSE	Support Services

Source: www.bnyadr.com.

A cost advantage
Dr. Reddy's Labs is a generic and proprietary pharmaceuticals maker that has been enjoying strong growth in the past two decades. The competitive advantage is the same for Dr. Reddy's as it is for most Indian companies: Educated labor costs are much lower in India than they are in the West, so the business is more profitable if the products are sold in world markets.

The company has wholly owned subsidiaries in several developed and developing markets, and many more third-party distribution arrangements. In the latest fiscal year, 79.1% of revenues came from international operations. The company has virtually no debt.

The shares are down in sync with the rest of the local stock market, so now is the time to take a look -- the stock looks cheap. The shares trade at 14 times earnings and 1.3 times sales.

No subprime issues
Indian banks are in good shape compared to their Western counterparts. There are no exotic derivatives, no subprime issues, just plain-old gathering of deposits and lending to consumers and businesses.

I have followed both HDFC Bank and ICICI Bank for some time, and both are extremely conservative. For the latest quarter, HDFC bank grew profits 45%, although that included an acquisition. There is a rise in non-performing assets, but that is typical as the local economy slows somewhat, and the company has increased reserves to account for that. Still, HDFC has very high net interest margins of 4.3%, accounting for the high profitability. The stock trades at about 15 times forward earnings and yields 1%.

ICICI Bank is the second-biggest in India and not as well run as HDFC -- net interest margin is only 2.3% -- but this is why the stock is much cheaper. It trades at only 10 times forward earnings, as well as a discount to book value. The shares yield 2.9%, and given the lower valuation, it may turn out to be a good bet on any recovery that comes in Asia in 2009.

A more diversified approach
For investors uncomfortable going the individual stock route, Matthews Asia Funds, a mutual fund family that specializes in Asia, offers a dedicated Indian fund, Matthews India (MINDX). I'm not aware of another dedicated mutual fund family that invests in the region, and in my opinion, the fund shop possesses a lot of regional expertise. Matthews India has been hammered along with the Indian market, and at present levels, it's a good time to take a look. The fund has an expense ratio of 1.28%, a low turnover rate of 25.6% (good for your taxes), and generally gravitates toward large-cap stocks as it benchmarks against the BSE 100 index.

More on emerging markets:

• Why All Emerging Markets Are Not Created Equal
• News Flash: Emerging Markets Aren't Safe Havens
• Is India's Miracle Over?