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Are emerging market stocks the best bets? - Views on News from Equitymaster
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  • Mar 4, 2010

    Are emerging market stocks the best bets?

    In the early part of the decade gone by, it dawned on sophisticated investors that countries like China and India will grow very fast. Much faster than the western world. The term 'emerging markets' was coined and our stock markets became the toast of the most of the global investment community.

    It is not just the foreign investors. If you listen to experts or have a chat with friends about investing, this point is likely to come up. India is going to grow very fast in the years ahead. Hence, Indian stocks are will make great investments.

    Old wine in a new bottle

    If you examine the issue closely, this is an old debate. The 'top down' school of investing says first pick the best economy. Within that the best sector and within that the best company. The bottom up school of investing says, focus on the companies. And your own intellectual and behavioral strengths and weaknesses.

    In our opinion, it is the second approach to investing that makes more sense. In the last century, there have been several countries that have grown fast. Be it the US, Germany, Japan or South Korea - all of them were 'developing' at some point in time. Similarly, most industries when they first emerge, clock in rapid growth. Be it aviation, plastics, computer hardware, software. All of them were the next big thing at some point. But investors didn't make money by just catching the wave as it emerged. For every investor who benefited from the winners that emerged out of these growth stories, many more burnt their fingers badly. Today, we speak of China and India. Of infrastructure and power.

    But just getting the economy or sector right is not sufficient. Far more important is the question of how predictable is it? Especially important is the question of how the competitive dynamics pan out. Every growing economy and industry eventually throws up several losers. If the competition is too brutal, then at the end of it all, there might not be any winners left at all. Exciting growth opportunities also come with another disadvantage - steep valuations.

    So how should conservative investors deal with the hype about growth - be it an economy or an industry? In our opinion, by taking stock of oneself. How familiar are you with the story? Can you predict the future financials of you investment with certainty? Does technology, regulation or competition make the future too complex to predict?

    In a recent interview, Warren Buffett was asked "Since emerging market economies are growing at two to three times faster than those of developed countries, what percent of one's equity portfolio should be in emerging markets?" He replied, "Your portfolio ought to be in businesses you understand, where you understand their future economics. And they may be in emerging countries, they may be in the United States...But sticking the name 'emerging country' after a stock does not make it better."

    In the end, self knowledge can count for more than all growth projections.



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