Gobble up This Emerging Market

Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Not all that long ago, investors poured money into the emerging markets, particularly into widely known "BRIC" -- Brazil, Russia, India and China -- stocks.  And they were rewarded with stellar returns. But now many investors are a lot more skeptical of the elusive and perplexing emerging markets. They worry about nationalization, border conflicts, confounding foreign policies, corruption, labor laws and the general uncertainty that looms over many of those companies.

To many of us, investing in emerging markets is a risky proposition.  We would rather pay a premium to invest in well-managed U.S. companies whose products we enjoy and business models we understand. 

Do emerging markets represent better value?

The MSCI Emerging Markets Index (NASDAQ: EMFN) trades at a paltry 10 times next year's earnings.  That is well below the developed market's multiple of 14 and also well below the average earnings multiples of both the Dow and S&P.

Russia trades at just a little over 4.5 next year's earnings.  China trades at more than 8x.  And Brazil still trades in the single-digits at just under 10x. If we assume that emerging markets are going to grow at a faster rate than developed markets, then those numbers practically scream bargain, right?

Except that one reason why those valuations seem attractive is that many emerging markets don't have nearly the same level of oversight.

Another reason is that emerging markets tend to have more companies in badly beaten-down sectors that are less stable and more volatile and fewer companies in the strong sectors.  Arguably all three of these economies, for instance, are driven by their energy and financial sectors. 

The implication, of course, is that if you were to assign a sector weight equal to the global market, then many of the emerging markets' valuations would not look nearly as attractive as they currently do. And many investors don't like the fact that many of these economies have raised their interest rates to protect their currencies, which oftentimes leads to lower profits for banks, a high cost of borrowing, and bad loans. 

In part, that explains the diverging spread between the Emerging Markets Financial Index, which has lost money this year, and the S&P Financial Sector Index, which is up by more than 25% this year.

Plus many of the foreign banks have comparatively high price-to-book ratios, which are oftentimes in excess of 1.

Why do I like this emerging market?

There are several reasons why you should consider investing in Turkey, a key strategic ally of the United States and a country that serves as a bridge between the "new Europe" and a poor but growing Middle East.

First, Turkey's economy is increasingly driven by its service sectors and industry.  Still, Turkey has a very strong agricultural sector, and it has proactively taken steps to reduce its dependence on foreign oil and gas, which will catalyze growth. 

Second, similar to many other emerging economies such as Russia, Turkey embarked in an aggressive privatization program that reduced state involvement in "infrastructure industries" such as banking, communication, and transportation.

Third, that reduction in governmental involvement, combined with pragmatic policies, has created a hungry, emerging cadre of talented middle-class entrepreneurs, which has expanded production beyond Turkey's traditional sectors (clothing, textiles, etc.) and improved productivity. The automotive, electronics, and construction industries, for example, are now a much more significant share of the export mix. 

Fourth, after Turkey's financial crisis in 2001, Turkey implemented many pragmatic reforms. Those reforms strengthened Turkey's economic fundamentals and provided a foundation to catalyze sustainable growth. 

Fifth, Turkey has a comparatively young population (the median age is below 30), low literacy rate (around 88%) and strong infrastructure. 

Sixth, Turkey is well-positioned to benefit from a global recovery. Many wealthy investors of countries in the Middle East such as Saudi Arabia, Egypt, and Kuwait invest in Turkey.  More importantly, inflows will flow into Turkey from Europe as the European economy rebounds. 

Seventh, as more capital flows into Turkey its debt will get upgraded by other rating agencies as it was in 2012, which will change investor sentiment and boost investor confidence. 

Eighth, with all of the political turmoil that Turkey has experienced (mostly countries close to Turkey), Turkish stock prices have fallen sharply. This bad news has created an attractive buying opportunity for patient investors who understand that Turkey is one of the most stable countries in the Middle East and arguably Eastern Europe.

How should you invest?

One of the easiest ways to invest in Turkey is to invest in iShares MSCI Turkey Index Fund (NYSEMKT: TUR).  That fund attempts to mimic the performance of the MSCI Turkey Index.

And you could also invest in the Turkish Investment Fund (NYSE: TKF). That fund is similar to the Dow 30 or S&P 500 in that it attempts to track performance of some of the largest companies in Turkey. 

Or if you are like me and you like to buy stocks, you should consider investing in Turkcell Illetisim Hizmetleri (NYSE: TKC), more commonly known as just Turkcell. 

I made a small position in Turkcell for three reasons: (1) Turkcell has a strong foothold in the mobile market (it has market share leadership, a phenomenal mobile communications network, a strong brand, a suitable platform for data transmission, etc); (2) Turkey still has a strong growth story; and (3) Turkcell has a very attractive valuation, especially considering its potential for sustainable growth.      

My Foolish take

Turkey is well-positioned, both literally and figuratively, to continue to grow at a rapid rate and emerge as a strong regional economy. To that end, it will be interesting to see whether or not Turkey joins the Shanghai Cooperation Organization, which includes countries such as Russia and China or aligns itself more with the European Union. Regardless, I believe that the Turkish market is oversold and has the potential for at least a 20-30% upside over the next year, with minimal downside risk.

With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!

Ryan Peckyno has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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