Emerging market tech stocks are raging
Technology stocks have been driving emerging markets indices north. In 2017 to date, the MSCI Emerging Markets index is up 25% — the largest gains in the past six years. On average, tech sector stocks in the emerging markets index have surged 75% in the year so far, outperforming the index three-fold.
The biggest five emerging market companies in the index are tech firms Alibaba (BABA), Tencent (0700.HK), Samsung (005930.KS), Naspers (NPN.JO) and Taiwan Semiconductor (2330.TW). They comprise almost 19% of the MSCI Emerging Markets Index (EEM) in terms of market capitalization.
UBS Strategist Bhanu Baweja states that the IT sector contributed to 47% of the rise in the MSCI Index so far. Of the 830 stocks constituting the MSCI EM Index, 10 stocks have surged 41% year to date. “You don’t see that every year, I’m very certain we haven’t seen that ever,” he mentioned in a note to investors.
Gains in emerging markets have been primarily driven by large bellwether stocks like Samsung, Taiwan Semiconductor Manufacturing, Alibaba, Tencent Holdings and Naspers. In the year so far, shares of these companies have rallied 56%, 47%, 108%, 94% and 73%, and have outperformed the popular FAANG stocks.
Emerging market tech equities are expected to gain further as smartphone demand is rising in these countries.
The tech sector is gaining importance in equity indices as these companies dominate stock trading. In 1995, the tech sector constituted merely 2% of the MSCI Emerging Markets Index, but now have risen to 27%. In the United States, tech stocks make up 24% of the S&P 500 Index (SPY).
John Vail, chief global strategist at Nikko Asset Management Americas who is bullish on Asian tech stocks believes stellar earnings are driving gains in the stocks of these companies. Further, Internet penetration growth in emerging markets is higher than developed markets.
Michael Lippert, portfolio manager of Baron Opportunity Fund, also has big investments in tech stocks and believes “data is the new oil.”
Ben Laidler, a global equity strategist at HSBC , said investing in emerging markets hasn’t changed all that much, even if the type of companies is different.
Chinese tech stocks form the largest chunk of the pie when it comes to emerging markets tech stocks. HSBC estimates China contributes nearly 71% of tech sector revenues in emerging markets, and has been key to growth of the tech sector in these markets.
However, some experts believe the rally in the tech sector is overbought, and a correction is pending. Rob Young, manager of the $65 million ICON Emerging Markets Fund is currently offloading his investments in tech stocks like Alibaba and Tencent. “These stocks are highly sensitive to earnings growth, and if there is any slight deceleration, the stocks get hammered,” he said.
Valuations
The MSCI Emerging Markets Tech index is currently trading at a PE of 21.2x while the MSCI US Tech stocks index trade at PEs of 25.2x. In comparison, the MSCI Emerging Markets Index trades at 15.8 times its past 12 months earnings.
Investors see valuations of tech stocks to be lucrative and see emerging markets stocks as a less expensive way to gain exposure to the high growth tech sector.
Stocks trading lower than their average price-to-earnings multiples or lower than the sector average price-to-earnings multiples attract investor attention because they’re considered cheap. The price-to-earnings multiple compares a stock’s price to its forward earnings per share. If a company trades at a high PE, it means investors are anticipating higher growth in the future.
Vipshop (VIPS), YY Inc (YY), Autohome (ATHM), Naver Corp and Baidu (BIDU) are currently trading at inexpensive valuations compared to their peers. They have one-year forward price-to-earnings multiples of 15.2x, 18x, 30x, 33x, and 34.4x respectively.
Meanwhile, 58.com (WUBA), Kakao Corp and Weibo are currently expensive. They have PE multiples of 388x, 102x and 97x respectively.
Analyst recommendations
Analysts are bullish on the technology sector in emerging markets based on favorable demographics and a growing Internet population. Kristina Hooper, the global market strategist at Invesco, believes emerging-market tech stocks are cheaper compared to their US counterparts and offer higher growth potential.
The table above shows the ratings of some large-cap tech stocks in emerging markets. Analysts are most bullish on big names like Alibaba (BABA), Tencent Holdings, NCSoft, Naver Corp and JD.com. Alibaba has received 47 buy ratings, and 3 hold ratings, while Tencent Holdings has received 44 buy ratings, and 2 hold ratings. Naver Corp has received 35 buy ratings, and 3 hold ratings. Comparatively, NCSoft and JD.com have received 35 and 33 buy ratings respectively. All these stocks have received no sell ratings.
