The Cheapest Market in the World

delfeldRussia is one big country.

It is the world’s largest landmass by a vast margin with 6.6 million square miles.  Giant companies such as Gazprom and Lukoil dominate the Russian economic landscape.  The big bosses in Moscow control these behemoths.

And right now, the Kremlin is struggling with political uncertainty, rampant corruption, weak productivity, and falling energy prices, all of which have hammered Russian economic growth and markets.

So why would anyone in their right mind invest in Russia right now? One reason: Russia’s stock market is the cheapest in the world.

And an American entrepreneur and investor who has made a bundle in basket case countries like Russia and Argentina put it to me this way: “to make money, it doesn’t have to get great, it just needs to get a little bit better.”

This is why Russia – trading at only 4.5 times earnings, presents us with a great value opportunity.

Russia is also a good example of the challenges facing investors trying to tap into emerging market opportunities. You have limited choices.

There are a few mutual funds of course. Then there are four Russian companies that trade as ADRs such as Mechel Steel, Mobile TeleSystems, Rostelecom, and Vimpel Communications.

There are an additional 37 Russian companies listed over-the-counter. These “pink sheet” listings is a growing trend for even the largest companies like Gazprom and Lukoil eager to avoid the high cost and regulatory burdens of the big board. Picking through this list to find the “pink sheet blue chips” takes patience, skill and judgment. Be careful.

Then there are exchange-traded funds or ETFs that trade like a stock as a basket of Russian stocks. The highest profile is the Van Eck’s Market Vectors Russia ETF (RSX) with energy and basic material companies accounting for 68% of its assets. RSX has $4 billion in assets and 95% of the companies in the basket have a market value greater than $5 billion.

While RSX is a decent proxy, it is very top heavy.

I suggest you look at many smaller Russian companies that offer the following advantages over the better-known giants:

private ownership and control

Government ownership and support comes at a high price. Smaller private companies fly a bit under the radar. They also tend to be more nimble and have the opportunity to grow faster. State-owned and controlled companies can hit speed bumps as government change regulations or priorities. With $100 plus oil, Russian energy giants may seem like the place to be but keep in mind that Moscow raises tax rates as oil and other commodity prices increase. This is a direct hit on profitability and share prices.

broader and deeper play on growth turnaround

Even marginal market reforms have and will continue to create winners outside of energy and commodities. The tax revenue from higher commodity prices filters back into the domestic economy sort of like a perpetual stimulus program. Smaller cap companies in a wide variety of industries are poised to capture this demand and turn it into profits for shareholders.

less research coverage equals “discovery” potential

Like small caps all over the world, Russian small caps are largely unknown and are covered by analysts only sporadically. As a test, look at the list of the ten largest Russian small caps below. If you recognize more than a few, you probably hail from Russia.

While it is difficult to invest in these Russian bear cubs, Van Eck’s Russia Small Cap (RSXJ) will get the job done.

RSJX offers good diversification with a 35% weighting in energy and materials, leaving more room for allocations to utilities (18%), industrials (15%), health care (8%), and other consumer (18%) sectors.

Try a double-barreled shotgun approach with RSX and RSXJ to take advantage of a market trading at only seven times earnings – a significant discount to the emerging markets index and about half that of the S&P 500.

Opportunity awaits,

Carl Delfeld.


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