Where the Bargains Are Now

Through the first third of this year, you were stupid to own foreign stocks. Because of investor concerns about a housing bubble in China, a debt crisis in Europe, and an all-around aversion to risk, the large-cap, U.S.-focused SPDR S&P 500 ETF outperformed the iShares Emerging Markets Index (NYSE: EEM) by some 6 percentage points and the global iShares MSCI EAFE (NYSE: EFA) index by almost 9 percentage points.

Since May, however, you've been stupid not to own foreign stocks. Investors, concerned about the U.S. economy and a weakening dollar, have been pulling billions of dollars out of U.S. stocks and plowing them into foreign markets with greater growth potential. So while the SPDR S&P 500 is down a little more than 2% since then, the MSCI EAFE is up 2%, and emerging markets are up 8%!

Ask yourself: Is now the time to buy emerging-markets stocks, or is now the time to buy U.S. stocks?

The answer is clear
Of course, the time to buy emerging-markets stocks was when they were out of favor back in April, making now the time to buy out-of-favor U.S. stocks. That may sound like a strange observation coming from your humble "Global View" columnist, but what has me excited about the current situation is that many seemingly American stocks are actually backdoor plays on emerging markets -- a reality that will become more and more apparent over time as these companies invest abroad and make international sales a larger and larger portion of their revenue pie.

Yet most of these stocks aren't followed by globally oriented analysts, but rather by industry-specific analysts who don't necessarily grasp or appreciate the international growth opportunities that lie ahead of these firms. As a result, foreign exposure within large U.S. companies is going underappreciated and therefore being undervalued by the U.S. investing community.

What I mean by that
Consider, for example, the plight of Johnson & Johnson (NYSE: JNJ). Although this consumer health-care giant has posted modest 5% annual sales growth overall over the past five years, the company has been growing its sales in Asia, Africa, and Latin America every year by a far more robust 12%. The market, however, isn't all that focused on this international growth because these emerging markets represent just 24% of Johnson & Johnson's total sales today. Significantly, though, that's up from just 18% of sales five years ago, and I suspect that Johnson & Johnson's sales in Asia, Africa, and Latin America will continue to grow not just on an absolute basis, but also to be a larger component of Johnson & Johnson's total sales -- eventually likely to be well more than 50%.

Johnson & Johnson, however, is selling for just 8.3 times EBITDA. Although that's in line with a peer group of other health-care and personal products multinationals such as Novartis (NYSE: NVS) and Procter & Gamble (NYSE: PG), it's dramatically less than well-known emerging-markets names such as Brazil's Natura Cosmeticos, China's Mindray Medical (NYSE: MR), or India's Dr. Reddy's Laboratories (NYSE: RDY).

Source: Capital IQ. EV = enterprise value. EBITDA = earnings before interest, taxes, depreciation, and amortization.

In fact, health-care and personal products companies in Asia, Africa, and Latin America trade for a median of 10 times EBITDA at present. If we assume that Johnson & Johnson's non-Asia, Africa, and Latin America sales are fairly valued at 8.3 times EBITDA, and apply that same 10-times multiple that emerging-markets names are getting on their EBITDA to the EBITDA J&J is generating in Asia, Africa, and Latin America, then this framework would suggest a fair enterprise value for Johnson & Johnson of a little more than $172 billion -- some 6% higher than today's valuation.

Big whoop
While no screaming bargain, that's a simple example of the kind of relative mispricing you can find today in U.S. stocks that have significant emerging-markets sales. Should you apply the same framework to other high-quality companies with international exposure in the S&P 500, you will undoubtedly discover additional bargains. Even better, these S&P 500 companies will help you put emerging-markets exposure in your portfolio on the cheap without exposing you to the kind of political and corporate governance risks that can plague other emerging-markets plays -- realities that I know have made many individual U.S. investors reticent about adding foreign names to their portfolios.

Although this isn't exactly the most exciting way to invest in emerging markets, remember that in the end investing is not about the story. Rather, it's about making money -- and you can do that by analyzing companies, even companies that hundreds of other professional analysts have looked at, with a slightly different, and in this case more global, perspective.

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