Astounding (and Surprisingly Safe) Yields in Emerging Markets

The astounding returns generated by investments in emerging markets like China, India and Eastern Europe are no longer breaking news. But until now, you may not have read much about the potential for high dividend yields from emerging market stocks.

Granted, the capital-appreciation component of emerging markets investing deserves the attention it's received. Thanks to several factors -- widely available technology, the Internet, the end of the Cold War and liberalized trade -- the world is a smaller place economically. Countries that once were isolated markets have become full participants in the global economy.

The emerging-markets boom has been led by the so-called "BRIC" countries -- Brazil, Russia, India and China -- but many countries outside of the BRIC leaders also are growing rapidly. This includes countries throughout Asia, Eastern Europe, Latin America, even Africa and the Middle East. For investors, emerging markets offer a geographically diverse feast of opportunities for strong gains.

For example, eager to catch up to the world's economic superpowers, these countries are investing billions of dollars a year in infrastructure spending -- on transportation networks, public utilities, factories and ports, and technology. This spending is creating plentiful jobs in emerging market economies and leading to a rising consumer class, which further increases economic activity.

Many emerging market nations also are enjoying boom times thanks their low labor costs relative to industrialized nations. Manufacturers around the world are shifting production to these emerging nations -- resulting in cheaper manufactured goods for consumers in the U.S., Japan and Europe, and more jobs and economic growth in emerging markets.

In many cases, emerging markets also are benefiting from commodity price increases over the past several years. Oil, gold, industrial metals and even agricultural products are getting more expensive -- and countries like Russia and China that export such goods are cleaning up.

As emerging-market economies have boomed, emerging-markets stocks have tremendous capital gains in recent years.

As you can see from our chart, the emerging markets story is enticing -- even without the added bonus of dividends...

(1.)  Where to Look for Income

But while the story of capital appreciation is one worth telling, income investors may feel like they get the short end of the stick.

There's a reason for that: emerging-markets tend to offer more capital gains opportunities than income opportunities. The majority of companies in emerging markets are choosing to invest extra cash back into the company rather than making substantial dividend payouts to their shareholders. That's not surprising: when an economy is booming, plenty of business opportunities are available to companies with extra cash.

However, high-yielding stocks certainly do exist in emerging markets. If you search stock markets around the emerging-market world -- from Brazil to Hong Kong to Poland to South Africa -- you'll find stocks a bounty of stocks offering high yields.

In fact, in writing this report, we found dozens upon dozens of emerging-market stocks paying out enormous dividends to their shareholders. But to truly find the best of the best, we had to narrow down our list. To do so, we looked in-depth at the companies and followed some of the basic tenets of income investing to weed the winners from the losers.

Our primary criterion was cash flow. Businesses that bring in a steady amount of cash day-in and day-out are the most likely to pay dividends dependably. In addition to a company's history of cash flows, we looked at the prevailing economic currents in the firm's industry and in the country itself. Companies with the wind at their backs are that much more likely to increase cash flow and increase dividend payments.

Secondly, we looked for firms we feel will continue returning cash to shareholders. Unlike bond payments, dividend payments aren't legally required. And contrary to what many novice investors often think, they certainly aren't guaranteed. Companies can cut or even eliminate their dividend payments altogether at any time. With this in mind, we looked for firms whose records indicate there will be plenty of cash available for future dividends.

Finally, although dividends are certainly an important part of the picture, they don't represent the whole story. In the end, the total return that a stock delivers is really a combination of its dividend yield and share appreciation. A stock may pay a decent annual dividend, but if its share price declines steadily year after year, then the net effect could be a flat or possibly even negative investment.

Although income investors are typically willing to trade significant capital gains potential for the relative safety of predictable income, we prefer to look for stocks that offer the best of both worlds with rich dividend payments and solid long-term growth potential.

One factor that influences a firm's capital appreciation potential is its cash flow, which we mentioned above. Not only does increased cash flow likely translate into increased dividends, it usually means like price appreciation as well. After all, to increase the money available to shareholders, the firm is usually has to increase its revenues and earnings -- two important factors in a stock's price.

After taking all of these factors into account, three emerging-market stocks in particular stood out. While they may be based in foreign countries, these stocks speak the international language of income investors -- dividends.