Value investing – the concept of buying stocks when they are inexpensive – has been around for decades. It is not an easy model to follow as investors need to sort through the stocks that are underpriced because their earnings potential is being underestimated or the stocks that are inexpensive for a reason, such as ineffective management and a maturing product market. Several investment analyses providers – including MSCI and Thomson – have attempted to group equities by countries to determine which ones are bargains. Some models include forward PEs, enterprise value/market cap and even GDP growth. Thomson’s pricing is based on intrinsic value – which incorporates a dividend discounting model.
Thomson, Reuters, and Starmine calculated the intrinsic value (IV) of each stock within a country. Then all values were aggregated and compared to the aggregate actual market price. An inexpensive country will be one with a low Price (P)/IV ratio while an expensive country will have a high P/IV ratio. Conversely, a country with a high IV/P ratio will be considered inexpensive. Countries considered in the study had more than 50 stocks trading in their markets with Starmine IV scores. About 50 countries were ranked by IV/P quintiles. The bottom quintile contains the countries that have the highest IV/P ratios, hence, the most undervalued. The countries in the quintiles were backtested by calculating the market-cap weighted return for each country and then the average return of countries within each quintile. Study lasted 60 months.
The graph below shows the P/IV trajectory of the most inexpensive countries. At the beginning, the market prices the countries at less than one half of the calculated intrinsic value. Over time, the countries move towards intrinsic value ending up at a 0.60 P/IV in about 60 months. Mean reversion in action indeed, driven by higher prices. Investors that bought when the country had a 0.40 P/IV profited more than investors who bought later.
The chart below shows that the bottom quintile of countries with the highest IV/P aggregate generated average returns of approximately 21% while the most expensive (or top quintile countries) only generated 3% average returns.
The table below shows the most undervalued countries by year in the past five years. Some of them are considered “frontier markets” such as Vietnam, while others are within emerging markets such as Peru, Turkey, and Russia.
The five most inexpensive countries in 2013 using the study’s methodology are (ranked from lowest to highest aggregate P/IV) are:
- Bulgaria
- Russia
- Pakistan
- Egypt
- Hong Kong
Another study by Morgan Stanley (NYSE:MS) ranking countries by Enterprise Value (EV)/Earnings before interest, taxes, depreciation and amortization (EBITDA) shows undervalued countries in Europe, including Austria, Italy, and Norway.
Furthermore, a JPMorgan Chase & Co. (NYSE:JPM) report released on April 20, 2013 downgraded Russia from neutral to underweight in JP Morgan’s Global Emerging Strategy portfolio. This is because of Gazprom OAO (PINK:OGZPY) (MCX:GAZP)’s dividend cut, which triggered a decline in income from Russian stocks and a lower dividend payout. Countries with low dividend payout ratios are not as attractive to investors, particularly institutions (e.g. pension funds) that rely on income for their portfolios. Weak oil and commodity prices can also affect Russian’s economy in turn depressing Russian stock prices. Finally, Russia is a consensus overweight, which may suggest that potential upside is already priced in by the markets.
Overall, studies based on mathematical measures such as P/IV or EV/EBIT need to be cross-checked with macro forecasts to provide a complete picture of the countries outlook. After all, countries may be cheap for several reasons, such as Russia.
One way to invest in an undervalued country includes purchasing ETFs. For example, iShares MSCI Hong Kong Index Fund (ETF) (NYSEARCA:EWH) and the thinly-traded Market Vectors Egypt Index ETF (NYSEARCA:EGPT).
