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Attractiveness of emerging markets by P/E and implied return on capital

Date: 22 Jan 2012 22:33

The goal of this article is to analyze attractiveness of BRIC and Vietnam stock markets using multiples.

Country attractiveness based on P/E ratio

The multiple which is often used an indicator of investment attractiveness of individual stocks or countries is P/E. Below are its values for a key index in each country plus S&P for comparison.

P/E for key emerging markets indices and S&P

  • China was the most expensive county by P/E since 1996 to 2011 except 2007 when Vietnam took the leadership
  • Vietnam was the most expensive country by P/E in 2007, but lost its leadership to China during 2008 crisis and have never recovered since
  • Russia had always the lowest P/E among BRICs and Vietnam
Questions about the past performance:
  • Can we say based on this data that Russia generated the biggest investment return and China the lowest in the observed timeframe?

P/E for key emerging markets indices and S&P

Questions about the future:
  • Can we say based on this data that Russia and Vietnam are the most attractive for investments for 3-5 years ahead?
  • Can we say that India is the least attractive?

Implied return on equity

Thinking about the questions above, everybody understands that direct comparison of P/E multiples for different stocks or countries is often incorrect as different earnings growth rates are implied. For example, expected growth for Russia in 2012 is about 3.6% while expected growth for China is 8.5%. The multiple which tries to fix this problem is PEG:


where g is taken as g*100 (for example, g=10% is used as 10). PEG multiple is even worse as it doesn't have any financial interpretation.

As P/E is widely calculated and published it's worth using it but with the correct inclusion of g in the formula:


This formula tells that if you want to compare attractiveness of stocks or countries, you should look at the implied return on equity r:

r= 1/(P/E)+g

Then the question which investors should ask is whether the implied return on equity is justified, too high or too low. Below is the implied return on equity for the analyzed indices:

Implied return on equity (re) for key emerging markets indices and S&P

Implied return on equity (re) for key emerging markets indices and S&P

This leads to interesting implications:
  • Before 2008
    • Investors assumed huge cost of equity in Russia
    • China, India and Brazil had similar r since 2001
  • Since 2008 crisis the order of countries changed:
    • Vietnam has the highest implied return on equity since 2009, Russia has the second since 2010
    • Russia stopped being attractive since 2008, and then became attractive for a short period of time at the end of 2008 - beginning of 2009
    • China and Brazil have the lowest implied return on equity
    • India is in the middle and decoupled from China and Brazil
    • Any of the BRICs + Vietnam have at least twice bigger implied return than S&P
Vietnam and Russia are the most attractive countries for investment in public stocks among BRIC + Vietnam.


In calculating implied return on equity the following assumptions were used:
  • g in the formula should be long term expected growth in earnings. It's hard to measure it retrospectively. Instead, g which happened/expected in the next 365 days was used.
  • Also, it's hard to get exactly earnings growth, so GDP growth was used.
  • This approach is theoretically not ideal, but does the job. The main goal of this exercise to broadly incorporate growth expectations in P/E analysis. For example, in 2010 Russia with g=4.0%+11.4%=15.4% is very different from India with g=9.7%+9.6%=19.3% and P/E ratios of these countries cannot be compared directly
  • g = real GDP growth + GDP deflator
  • Period for the above data: g is measured for the 365 days ahead of the time of P/E. For example, for 30 March 2011 real GDP growth =~ ¼ * real GDP growth 2011 + ¾ * real GDP growth 2012
  • When the growth was not available or the period is in the future, short term forecasts were used
  • For GDP deflator forecasts (2011-2013) CPI forecast was used


Below is P/E ratio and implied return on equity for S&P separately as the historical data is available for longer periods than for BRICs and Vietnam: P/E for S&P 1954-2012

Implied return on equity (re) for S&P

Russia had the fastest nominal GDP growth in USD in 2000-2009 with China only second

Date: 05 Jan 2011

Many investors focus on real GDP growth while thinking about perceptiveness of investments to a particular country. And this is really strange approach as real GDP growth is
  • real
  • measured in local currency while what investors care about is
  • nominal returns
  • measured in USD
The average expected equity returns over many years are normally expressed by the formula:

Expected equity return = Expected real GDP growth + Expected inflation + Expected dividends yield

If you want to measure it in $, you should add change of exchange rates.

The good explanation and data for this you can find in many articles in the internet. Here I will just quote Warren Buffet made to Fortune Magazine back in November 1999 right before dot com bust:

“Let's say that GDP grows at an average 5% a year--3% real growth, which is pretty darn good, plus 2% inflation. If GDP grows at 5%, and you don't have some help from interest rates, the aggregate value of equities is not going to grow a whole lot more. Yes, you can add on a bit of return from dividends. But with stocks selling where they are today, the importance of dividends to total return is way down from what it used to be.”

The key component in this equation like Buffet mentioned is nominal GDP growth while dividends returns nowadays are small and cannot cause big differentiation. If we take a look at Nominal GDP growth in USD for 20 biggest countries (by GDP in 2009) for the period of 2000-2009, surprisingly we will find that Russia was the first one, with China only the second and India the forth. This analysis also gives insight about the country which will be on radar of EM investors soon: Indonesia. I have already seen BRIIC abbreviation.

Real vs. Nominal GDP growth for 20 biggest countries

In many GDP growth discussions Russia was not even mentioned in the last five years. Some want to exclude it from BRIC. Why were investors so inconsistent using real GDP growth which was not even close for their ultimate goal – nominal $ returns?

Let’s also see what the reasons were behind so drastic differences between real and nominal GDP growth.

Growth structure of nominal GDP in $ for top-20 countries, 2000-09

In many cases this was high inflation that secured leadership in nominal GDP growth like for Russia and Indonesia. In case of China and Euro zone countries it’s also devaluation of local currencies. It’s worth to mention that Russia was the only country out of this top-20 with negative population growth which ate 0.3% GDP growth annually.

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20 Apr 2024 23:41