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Home > Investments > Emerging Markets

By Michael Godfrey and Matthew Vaight | Published May 30, 2012

Emerging markets: Uncovering hidden GEMS

Companies from emerging markets have tended to compete with peers in developed economies on the basis of cost, but a number are now world-class businesses in their own right.

The combination of increasingly professional management teams and innovative products and technology has transformed several emerging market companies into global industry leaders.

Size doesn’t matter

The growth of firms in the developing world has been truly astonishing, however when it comes to identifying attractive investments, size does not always matter. Companies often expand inefficiently by failing to deliver returns on their investments above the cost of capital.

What really matters is value creation. The key characteristic of a ‘great’ company is whether or not it is focused on creating long-term value for shareholders.

Such a company should have management that allocates capital efficiently and a strategy to ensure that the business can grow profitably and generate sustainable returns.

Profitable growth

Trust is also an important aspect of investing in emerging markets and close attention must be paid to corporate governance standards.

Management teams that make sensible use of investors’ capital are favoured. Encouragingly, corporate governance among emerging market companies has improved markedly in recent years and many companies that have incredibly strong cultures of running their businesses for profit, for cashflow and for investors have emerged.

In searching for potential investments, particular attention is paid to a firm’s fundamentals, such as its assets and business model. This helps to identify businesses with assets that can generate cashflows for shareholders in the future. We have a strict valuation discipline where companies whose potential is not fully appreciated by the market are sought. This focus on valuation is important as many investors, particularly within emerging markets, tend to overpay for growth.

Another feature of investing in emerging markets is that businesses are not always run for the benefit of minority shareholders. In Brazil, China and Russia there are numerous state-owned enterprises. They are used to deliver social goals, such as sustaining economic growth and providing employment, as well as a means for governments to maintain control of key industries. For instance, as Graph 1 shows, in China more than 80% of the stockmarket is made up of state-owned enterprises in which the government retains a majority stake.

However, a diverse selection of well-managed companies that are committed to creating value for shareholders can still be identified. Even in China, there are entrepreneurial companies with good corporate governance that are able to generate healthy returns for shareholders.

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