3 stocks this investor is watching in an undervalued part of the market

It’s easy to see why investors have been loading up on US equities for their international equities exposure. After all, the S&P 500 is up over 25% in the past year and some of the biggest brand names are on offer there. But, as investors increasingly question whether parts of the market are looking expensive, Ox Capital’s Dr Joseph Lai suggests another part is offering cheap starting valuations.

Emerging markets.

While this part of the world has copped a bad rap in the past decade, Lai believes that a range of factors are creating opportunities, such as government reforms in Indonesia, India, Vietnam and Brazil and infrastructure investment. He also notes that these countries are reaping the rewards of diversifying their supply chains away from China.

“A lot of these countries are growing in the high single digits to double digits,” says Lai. 

It’s a scenario that reminds him of China’s growth 15-20 years ago.

“Consumption was growing, infrastructure getting put in, exports booming, and it makes a nice prospective market to invest in, particularly when the starting valuation is cheap in these markets,” Lai says.

From his perspective, the key to exposure and managing volatility comes down to selecting high-quality franchises with earnings growth.

In this episode of The Pitch, Lai discusses the opportunities he sees in emerging markets and how to invest in these markets. He also shares three companies he believes reflect the opportunities in emerging markets.

This interview was recorded on Wednesday 19 June 2024.

Edited Transcript

What is your definition of emerging markets?

Emerging markets refer to a group of economies that are on the way to becoming developed markets. What it refers to are those countries that are less risky than the real frontier markets like Africa, which have grown to a certain size but have not yet reached the stage of developed markets. For us, this predominantly refers to countries in Asia and Latin America. Those are the countries of focus for us.

Are there any particular markets that you focus on?

We particularly like those economies that have gone through some tough times in recent years and are post-the-tough times. What happens on a lot of occasions is that good reforms are undertaken and implemented and then in the subsequent years, there are a lot of positive dividends to be achieved by those economies.

There are a few countries that belong to this category. This includes India, Indonesia, Vietnam, Brazil and to some extent, China as well, which has gone through this tough transformation. We pay a lot of attention to these countries because we believe there’s a lot of upside in the medium term.

Investor perception of emerging markets has lagged developed markets. Why do you think that is and do you think investors are wrong in this perception?

Emerging markets have not been the best performers in the last decade. The developed markets, particularly the NASDAQ have been the place to be and we can feel the hype and excitement over AI in recent months. A lot of people’s money is in certain markets, but away from emerging markets. The reason for this I can put down to three points.

First of all, after the global financial crisis more than 10 years ago now, these developed market equities were very, very cheap. It was prospective at the time.

Post the GFC, there was a period of disinflation, and low inflation, which again favoured developed markets.

Lastly, in recent years the strong US dollar and rising US rates are negative for emerging markets.

All up the last decade hasn’t been a pleasant time for emerging market equities. When I first started in the business more than 20 years ago, the question I got asked was ‘Why bother investing in developed markets? Because there’s no growth. Emerging markets were where the growth was. 

Now, it’s the reverse. I guess the outcome of that is emerging market equities are typically extremely cheap, bearing in mind the market hasn’t really moved in 10 years compared point to point. In the meantime, these economies have typically grown 5-10% a year.

So you can imagine there are a lot of opportunities very cheaply valued. The initial problems of low inflation, high issue valuation and, we believe the strong US dollar, are all reversing going forward. We think it’s a prospect over the medium term.

Where are you seeing the key opportunities?

The key economies that have undergone reforms are, as I mentioned before, Indonesia, India, Vietnam and Brazil. We think it’s quite exciting what is going on because a lot of these countries are benefiting from the diversification of the supply chain away from China over the last few years. They’re getting investments into building factories and stuff like that.

Also, the governments in these countries are quite good now in trying to do things to attract investment. So infrastructure is getting put in, like roads, rail, power stations, airports and the like. As a result, exports are growing quite nicely in these countries when most people would think ‘deglobalisation – exports are not doing well’. A lot of these countries are growing high single digits to double digits, particularly in countries like India, Indonesia and Vietnam. This really reminds me of what China went through about 15-20 years ago.

Consumption was growing, infrastructure getting put in, and exports booming, and it makes for a nice prospective market to invest in, particularly when the starting valuation is cheap in these markets

Can you share some examples of companies that reflect these sorts of opportunities, you're seeing?

One of the key stocks for us is Reliance Industries (NSE: RELIANCE). This is the dominant Indian operator in the internet space, in retail and in all things related to the cloud and potentially AI in the future. It’s growing at 15-20% a year and is dominant in what it does. It’s available on around a 20x PE multiple. We think it’s highly prospective.

On top of that, there’s a company that I think some viewers may be familiar with now. It’s called BYD (SHE: 002954). This is a very dominant electric vehicle or hybrid vehicle maker in China and it’s growing extremely fast domestically. It’s also just starting to export cars to the rest of the world. It’s absolutely leading in the technology, in electric vehicle manufacturing, in the cost they can achieve. They will be competitive even with some tariffs being applied to them in some parts of the world. It’s on a 20x multiple for a company that is just starting to tap the global market which it is, I think, the absolute leader in terms of electric vehicle manufacturing.

Another stock that we think is prospective is a company that is in the middle of the AI revolution. It’s a company that is based in Korea. It’s called SK Square (KRX: 402340). Basically, all the high-speed memory that goes into the NVIDIA (NASDAQ: NVDA) chips is supplied by SK Hynix which is owned by SK Square. We get to participate in the AI revolution by paying only 3x earnings for this business.

What should investors keep in mind when it comes to investing in emerging markets?

Emerging markets are a big part of the world. It is about 60% of the world’s GDP, generates the bulk of real growth in the world and in fact, has the majority of the world’s population. However, it is grossly underrepresented in most people’s portfolios and in the indices. I think it’s about 13% of global indices. We think ultimately there is likely to be a rubber band effect at some point. Whether the weighting goes up, probably through valuation improvements, it’s quite cheap. We think it’s underrepresented.

The second point is this. There is an understanding of the nuances involved in investing in emerging market equities. I mean understanding the company, the management, the industry dynamics and also the regulatory landscape. The requirement there is a bit higher. So it means that one has to do a lot more homework or get someone who can help them with that.

How can investors access exposure to emerging markets in their portfolios?

I think a more astute way to access emerging market equities is to find stocks that are quality franchises with a high level of certainty of earnings growth delivery. This is what we look for because we believe that the future of EM is these kinds of franchise stocks which will grow bigger and bigger in the next three to five years, as opposed to the story of old stocks - typically commodity producers or heavy industries where some countries still dominate the indices. So, we think being selective and choosing the better businesses within these economies can deliver very interesting and prospective returns.

Take advantage of the rapid growth in Asia and emerging markets

Ox Capital's investment approach is to identify the immense changes taking place in Asia and other key emerging markets to find investment opportunities. To learn more, visit their website, or the Fund Profile below.

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