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Typically, investors don't believe that companies in emerging markets pay worthwhile dividend yields and rarely if ever select stocks from emerging markets while constructing an income-generating stock portfolio. In addition, income-seeking investors believe that the degree of risk and volatility of emerging market stocks makes them unsuitable for investing for income purposes. However, I believe otherwise. In my opinion, you can incorporate dividend-yielding Latin American companies into your income portfolio and use them as an important tool for managing risk and enhancing returns.

I have formed this view since first of all, the stocks are cheaper based on forward price to earnings ratios, thereby giving you increased buying power, allowing you to increase portfolio returns. Secondly, emerging countries have higher GDP growth rates, especially since the global financial crisis and the European sovereign debt crisis has triggered economic downturns in most developed economies. An example of this is the 4% GDP growth rate forecast for Latin America, which is more than double the 1.1% forecast for the eurozone and 1.8% forecast for the U.S., and almost double the 2.3% forecast for Japan. This bodes well for earnings and income growth for Latin American companies and demonstrates that if used correctly in an income generating portfolio, they can be an important tool for enhancing investment returns.

Thirdly, by investing in dividend-yielding Latin American stocks, you are accessing the advantages of further diversifying your stock portfolio, across not only market sectors and industries, but also countries. This allows you to reduce the risk of being exposed to economic and political events that may only affect developed countries. Finally, emerging market currencies are typically undervalued in comparison to the U.S. dollar, and as their economy strengthens, those currencies will typically catch up in value, providing you with an additional opportunity to enhance returns.

It is important to understand that by investing in Latin American companies you are accepting a higher degree of risk, especially sovereign risk that does not exist when investing in companies based in developed countries such as the U.S., Australia, Japan or the eurozone. Therefore, it is important that investors mitigate this risk through firstly, not concentrating all of their investments in one or two sectors, or industries, or countries in Latin America.

Secondly, investors should only consider purchasing stocks that have been listed on a major U.S. exchange in the form of American Depository Receipts (ADRs). By using ADRs, rather than investing directly in Latin American stocks through local exchanges, investors are accessing a number of advantages, which include:

  1. The transaction costs for ADR trades are much lower than what they'd be if executed through local Latin American stock exchanges.
  2. ADRs allow investors to avoid being trapped into the huge currency spreads most banks charge when converting U.S. dollars to other currencies.
  3. There is a greater degree of regulatory control and transparency associated with major U.S. exchanges that doesn't exist on Latin American exchanges.

For this article, I have compiled a list of medium- to large-cap Latin American companies. Each has a market cap greater than $2 billion, is listed as an ADR on a major U.S. exchange, and has a dividend yield of 3% or more. This is only a high level summary and before considering investing in the any of the companies listed, it is important to conduct further research and due diligence to ensure that they are appropriate for your investment goals.

Company

Dividend Yield

Dividend Payout Ratio

EPS Growth (5 Year Historical)

Beta

Forward PE Ratio

Banco Santander Brasil SA (BSBR)

5%

46%

26%

1.81

11

Petroleo Brasileiro SA (PBR)

4%

41%

11%

1.76

9

Companhia de Bebidas das Americas (ABV)

3%

74%

48%

0.89

21

Vale SA (VALE)

7%

35%

29%

1.75

6

Banco Macro SA (BMA)

10%

45%

24%

1.14

4

Braskem SA (BAK)

6%

34%

24%

1.69

25

Telecom Argentina SA (TEO)

12%

78%

1%

0.93

5

Ecopetrol SA (EC)

4%

50%

2%

0.78

11

Gafisa SA (GFA)

4%

39%

48%

3.04

10

TAM SA (TAM)

6%

N/A

32%

1.48

14

I have provided a brief summary of each of the stocks below:

Banco Santander Brasil SA
Banco Santander Brasil is a separately listed Brazilian subsidiary of Spain's Banco Santander SA (STD) and operates as a full service bank in Brazil. It is a financially separate and independent entity from its deeply troubled parent. The bank has reiterated that it is not funding its Spanish parent and that it has a model of complete independence regarding liquidity and capital. For the full year 2011, it reported a 16% increase in revenue and a 5% increase in net income from 2010.

The bank pays a solid dividend yield of 5%, with a payout ratio of 46%, which as a quick-and-dirty measure of dividend sustainability indicates that the dividend is sustainable. In addition, at its current trading price of $10, it appears to be relatively cheap with a forward PE of 11, although it is a volatile stock with a beta of 1.81. This can be a turn off for yield-seeking investors, as preservation of capital is a key consideration when investing for income. Finally, at its current trading price, it appears to be significantly undervalued by the market with an earnings yield of 12%, which is greater than the yield of ten-year Treasury bonds.

Petroleo Brasileiro SA
Petroleo Brasileiro is one of the largest energy companies in the world and is partially owned by the Brazilian government. It is involved in the oil and natural gas exploration, production, refining and transportation businesses globally. For the full year 2011, it reported a 15% increase in revenue and a 5% fall in net income from its 2010 results.

The company pays a solid dividend yield of 4%, with a payout ratio of 41% indicating that the dividend is sustainable. At its current trading price of $28, it appears to be relatively cheap with a forward PE of 9, although it is a volatile stock with a beta of 1.76. Finally, at its current trading price I believe the company is trading at a significant discount, as it has an earnings yield of 13%, which is more than five times the current risk-free rate.

Companhia de Bebidas das Americas
Companhia de Bebidas is a South American brewery company that produces and distributes beer, draft beer, carbonated soft drinks, malt and other non-alcoholic and non-carbonated products in the Americas. For the full year 2011, it reported an 8% increase in revenue and a 14% rise in net income from its 2010 results. The company pays a dividend with a yield of 3% and a payout ratio of 74%. In my opinion, while this is a high payout ratio, it does indicate that the dividend yield is sustainable.

At its current trading price of $41, I believe that Companhia de Bebidas is expensive compared to the other stocks in the list, with a forward PE of 21. However, it is not as volatile as the majority of the other stocks as it has a beta of 0.89. This is a plus for yield-seeking investors, as it indicates there is a lower risk of capital erosion. Finally, at its current trading price, it appears to be fairly valued by the market with an earnings yield of 4%.

Vale SA
Vale is a large global resources company that engages in the exploration, production and sale of basic metals in Brazil and internationally. The company also has fertilizer, logistics, and steel businesses. For the full year 2011, it reported a 24% increase in revenue and a 25% rise in net income from its 2010 results. The company pays a solid dividend yield of 7%, with a payout ratio of 35%, indicating that the dividend yield is sustainable.

At its current trading price of $24 and with a forward PE of 6, it also appears to be quite cheap in comparison to the other stocks on the list. However, it has a relatively volatile price with a beta of 1.75. Finally, at its current trading price, I believe that it has been unfairly discounted by the market as it has an earnings yield of 19%, which is substantially higher than the risk-free yield.

Banco Macro SA
Banco Macro is a full service bank that provides the full suite of banking and financial products and services to individuals, entrepreneurs, companies, and corporate customers in Argentina. For the full year 2011, it reported a 15% increase in revenue and a 17% rise in net income from 2010. The company historically has paid a solid dividend yield of 10%, with a payout ratio of 45%, which as a quick-and-dirty measure of dividend sustainability indicates that the dividend is sustainable. However, recent changes to the bank capital adequacy requirements by the Argentinian Central Bank have meant that Banco Macro will not pay a dividend in 2012.

At its current trading price of $21 with a forward PE of 4, it also appears to be quite cheap in comparison to the other stocks on the list. Its price is also not as volatile as the other companies listed, as it has a beta of 1.14. I also believe that at its current trading price, it is heavily discounted as it has an earnings yield of 21%, which is significantly higher than the risk-free rate of return.

Braskem SA
Braskem produces and sells petrochemical and thermoplastic products in Brazil and globally. For the full year 2011, it reported a 26% increase in revenue and a 127% drop in net income from its 2010 results. The company pays a dividend with a yield of 6%, and has a payout ratio of 34%, which indicates that the dividend is sustainable.

At its current trading price of $17 it appears to be quite expensive in comparison to the other stocks, as it has a forward PE of 25. I also believe that it is fairly priced when its earnings yield of 7% is taken into account, as this represents a risk premium of around 5% above the risk-free rate of return, which I believe is a comfortable risk premium over the risk-free rate.

Telecom Argentina SA
Telecom Argentina provides fixed line and wireless telecommunication services in Argentina. For the full year 2011, it reported a 26% increase in revenue and a 33% rise in net income from 2010. The company pays a solid dividend yield of 12%, with a payout ratio of 78%, which as a quick-and-dirty measure of dividend sustainability indicates that the dividend is sustainable.

It is currently trading at around $19, which with a forward PE of 5 makes it look quite cheap in comparison to the majority of the other stocks on the list. It is also less volatile than many of the other stocks, with a beta of 0.93. In my opinion, the stock is unfairly discounted by the market at its current price. The company has an earnings yield of 15%, which is substantially higher than the risk-free rate of return.

Ecopetrol
Ecopetrol is a Colombian-based integrated oil company that operates in Colombia, Peru, Brazil, and the U.S. Gulf Coast. For the full year 2011, it reported a 57% increase in revenue and a 90% rise in net income from 2010. The company pays a dividend with a yield of 4%, with a payout ratio of 50%. This is a quick-and-dirty measure that the yield is sustainable.

At its current trading price of $60 and a forward PE of 11, it is cheaper than some of the other stocks on the list. It is also the least volatile of the stocks listed, with a beta of 0.78. Finally, at its current trading price, it appears to be fairly valued by the market with an earnings yield of 6%, which gives an investor a risk premium of around 4% over the risk-free rate. Overall, I believe as a dividend stock, Ecopetrol is a good addition to any income-generating stock portfolio, although further investigation would be needed by prudent investors.

Gafisa SA
Gafisa is a Brazilian building company that constructs residential buildings in Brazil. For 2011, it reported a 6% drop in revenue and a 309% rise in net income from 2010. The company pays a dividend yield of 4%, with a payout ratio of 39%, which I believe indicates that the current yield is sustainable.

At its current trading price of $6 with a forward PE of 10, Gafisa is relatively cheaper than some of the other stocks on the list. However, it is the most volatile stock listed, with a beta of 3.04. This, I believe, makes it unsuitable as an income-generating stock and I would not consider adding it to an income-generating stock portfolio. Finally, I believe that Gafisa, at its current trading price, has been unfairly discounted by the market with an earnings yield of 11%.

TAM SA
TAM is a Brazilian based airline that provides passenger and cargo air transportation services domestically and internationally. For the full year 2011, it reported a 14% increase in revenue and a 153% fall in net income from its 2010 results. The company pays a dividend with a yield of 3%.

At its current trading price of $25 with a forward PE of 14, it appears to be expensive relative to the majority of the other stocks on the list. It is also relatively volatile, with a beta of 1.48. Finally, at its current trading price, it appears to be overpriced as it has an earnings yield of -5%. TAM, at this time, is in the process of finalizing a merger with the Chilean airline LAN (LFL).

Source: 10 Dividend Yielding Latin American Stocks For 2012