Click to enlargeWith US investors largely focused on domestic matters these days, it can be easy to miss potential opportunities in international investing. One such opportunity that has recently come to our attention is Russia. Bear in mind, this market comes with a hefty warning label - investors looking to lower the volatility of their portfolio can stop reading here. But for those with a higher risk tolerance, there are three reasons to consider Russian equities:
The most obvious attraction of this market is its low valuation. By any measure, Russian equities look exceptionally cheap, both compared to their history and other emerging markets. The Russian MICEX Index is currently trading for less than 6x earnings, compared to a 10-year average of over 9x earnings. While most emerging markets look inexpensive compared to their history, Russia is an extreme case. In the past, Russian stocks have normally traded at a discount of around 30% to other emerging markets. Today, stocks in Russia trade at a 53% discount. Looking at price-to-book, the story is the same. The MICEX is currently trading at a 20% discount to its book value, one of the cheapest valuations in the world.
While there are some very legitimate reasons that Russian equities should be this cheap, profitability is not one of them. Companies on the MICEX exchange, have a return-on-equity (ROE) of over 18%. This is in line with both Russia's long-term average as well as the average for other emerging markets. In fact, when you compare valuations with market profitability, Russia appears to be one of the more under-valued markets globally.
Interesting energy play
There are a number of very good and obvious reasons Russia should trade at a discount: questions surrounding its long-term political stability, a lack of transparency and less-than-stellar corporate governance, to name a few. That said, it's worth pointing out that these issues are not new. Despite the recent protests, it's not clear that Russia is any less stable than it was in 2010 when the stock market traded for over 20x trailing earnings.
At the same time, some things have actually improved. Inflation is expected to be 3.70% in 2012 and a similar level in 2013. This marks a significant improvement from 2011 when inflation was over 8%. While growth is expected to slow this year, from 4.3% in 2011 to 3.70% in 2012, this is a relatively mild slowdown compared with other emerging markets, and growth is expected to stabilize in 2013. Finally, unlike many developed markets, Russia runs both a current account and budget surplus and has little to no any external debt.
Again, Russian equities come with more than a few caveats. The market is volatile - much more so than even other emerging markets - and is heavily exposed to oil prices (roughly 50% of the market cap comes from Oil & Gas companies). While they're not for everyone, investors that are looking for a more aggressive, as well as cheap, play on emerging markets may find Russia an interesting option.