(Fortune Magazine) -- It has become an investing truism of late: If you want stocks with high-octane potential, you're wise to invest in the fast-growing economies of emerging markets. The result has been frenzied demand for such stocks and skyrocketing valuations.
The MSCI Emerging Markets index has risen 67% in the past year, and China's main stock index now trades at a price/earnings ratio of 32, more than 50% higher than that of the S&P 500. Investors find themselves in a quandary: Yes, new economies have the richest potential, but who can afford those prices?
Some international stock managers have found an answer. They're buying shares of companies in established economies that have significant exposure to emerging markets. Giant multinationals like Siemens (SI), Unilever (UN), and Procter & Gamble (PG, Fortune 500) now get more than 30% of sales -- and their fastest growth -- from places like China, Brazil, and India.
"It's the best of both worlds," says Keith Walter of the Artio Global Equity Fund (BJGQX), whose 3.5% annualized return over the past five years beats developed-world stock funds by 1.4 percentage points. "The valuation is something you can stomach, and the Western economies themselves are improving."
There's another advantage: Stocks in developed-world companies typically have less risk and volatility. Don Gervais, who oversees $65 billion as global head of fundamental equity client portfolio management at Goldman Sachs Asset Management, notes that as the typical emerging-markets fund fell by 50% in 2008, Western companies with diverse exposures fared far better. "They tend to be able to weather the storms," says Gervais.
Walter of Artio Global suggests buying lower-priced European and U.S. stocks with significant operations in newer markets. Siemens, the $124 billion German conglomerate that sells everything from traffic-control systems to health-care products, is one of his top holdings. It garners 30% of sales from developing markets, and recent cost cuts helped Siemens beat earnings expectations by 64% last quarter. Its shares trade at 14 times next year's estimated earnings.
Rising energy demand in China, India, and other developing countries will benefit U.S.-based oil services giant Schlumberger (SLB), predicts Simon Hallett of Harding Loevner's International Equity Fund (HLMIX). "The oil exploration and production business is really characterized by declining production," he says. "So oil companies have been forced into offshore West Africa, Latin America, and Asia." Schlumberger trades at 22 times next year's earnings, below its five-year average of 25.
Finally, Jim Moffett, who runs the $5.1 billion Scout International Fund (UMBWX), last fall bought shares of Standard Chartered (SCBFF) because the London-based bank generates 90% of sales in Asia, Africa, and the Middle East but still trades at a reasonable 13 times next year's earnings. Like the other managers, Moffett, whose fund has beaten 92% of competitors in the past decade with returns of 4.6% a year, likes the mix of potential and reduced risk: "We'd rather participate in [broad growth] than bet on Chinese stocks."
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