Is There a Safe Way to Profit in Emerging Markets?

emerging marketsNow, before anyone gets too excited or starts thinking that I’ve lost all my marbles after putting the words “safe,” “profit” and “emerging markets” into one sentence, let me be clear about something. Emerging markets are a risky gamble on which to bet your money, there should be no doubt about it. However, emerging markets are also the only places in the world left where there is rapid economic expansion and where businesses enjoy the fastest growth rates. Still, with all that cash coming from every which corner of the world, investors are now looking into safer options in emerging markets as well, such as companies that pay regular dividends.

Here are some statistics that should put things into perspective. According to Bloomberg, comparing the 50 stocks comprising the MSCI Emerging Markets Index that pay the highest dividends with 50 stocks in the same Index with the fastest growing earnings, the dividend-paying group advanced 26% so far in 2010, while the second group advanced 13%. That is a significant change from the past five or six years. But the world has also changed after the crash of 2008 and the recession of 2009, and yields in the emerging markets have become much more attractive than those in the developed markets. As usual, that is only one part of the story.

The stampede towards emerging market dividend-paying stocks has already begun, partly prompted by ultra-low yields on bonds, literally everywhere. In addition, in Brazil and Thailand, for example, the government has raised taxes to prevent currencies from surging too much, too fast. Such policy decisions have largely left stocks in those regions intact, but have eroded long-term bond yields; hence, the renewed interest in emerging markets equities. And to further reduce risk exposure, investors are now focusing on dividend stocks.

The emerging markets are most certainly changing, too. More and more companies are rewarding their shareholders with dividends. Out of the 754 stocks comprising the MSCI Emerging Markets Index, 634 have paid dividends at the end of the third quarter. Additionally, there were 52 stocks that have generated yields in excess of 5.64%, which is the average annual yield on corporate bonds issued by emerging markets companies.

I don’t usually recommend specific stocks in PROFIT CONFIDENTIAL articles, but I do have a couple of suggestions for investment ideas. If you looking for relatively safe, dividend-paying stocks, look in the emerging markets’ utility sector. There is nothing wrong with owning a defensive stock here and there that also gives you cash every quarter. Another excellent source of steady dividend-paying stocks is the so-called “sin sector,” such as companies operating casinos or selling alcohol.

Now, if I were truly to play the devil’s advocate, I could argue that this flight to dividend-paying stocks in the emerging markets could be a sign that the entire market has inflated and could burst at any time. At face value, there might be something to it. To illustrate, the MSCI Emerging Markets Index has advanced about 13% so far in 2010, while the S&P has gained about 6.4% at this point. But I don’t think equities in emerging markets are in danger of bursting, at least not just yet.

I’ve been writing about the tectonic shifts that are currently happening between emerging and developed economies. The fear of emerging markets I’m seeing has nothing to do with their expanding economies, trade and budget surpluses, or strong currencies. It is the old kind of fear rooted in the mistrust towards emerging markets in general. After all, past transgressions, such as lack of transparency and poor regulatory oversight, have left many early investors with a foul taste in their mouths.