How To Profit From The Global Middle Class

In the generation after World War II, air travel changed the face of business and leisure. 

#-ad_banner-#Vast distances could suddenly be traversed and companies like Boeing (NYSE: BA), Douglas Aircraft and Fokker sold all the planes they could build. The Brazilian government wanted in on the action, and in 1969, launched Embraer (NYSE: ERJ). Few expected a country like Brazil, which had not yet developed a mature manufacturing base at that point, to have any chance of building a global jet maker that could compete with established Northern Hemisphere rivals.

It was a bumpy flight for this aviation upstart, which was almost shut down in the early 1990s before the government decided to privatize it. Soon thereafter, Embraer listed its shares in Brazil, and its American depositary receipts (ADRs) began trading in the U.S. in the summer of 2000 at around $13 a share, moving into the low $20s a year later.

Yet the events of 9/11 would doom air travel for the foreseeable future, and this stock plunged to around $8 in October 2001.

Of course, as we now know, air travel didn’t cease to exist. And as the airline industry recovered, so did Embraer, which began rolling out leading-edge regional jets. Shares soared above $40 by 2007, delivering a 400% gain for investors willing to focus on such a seemingly risky emerging-market stock. These days, Embraer racks up more than $6 billion a year in sales.

Embraer’s success highlights a key fact that many investors overlook: Emerging markets are now home to some of the most dynamic and fastest-growing companies in the world. And if you catch these companies at the right phase of their growth trajectory, you can reap huge profits.

Take Honda (NYSE: HMC), for example. U.S. consumers fell madly in love with the company’s new Accord and Civic cars back then, and savvy investors could have bought Honda’s ADRs for just $0.75 apiece (on a split-adjusted basis). Shares have risen 4,500% since then. In that time, shares of GM (NYSE: GM) have barely budged.

The key question: How do you find such growth stocks?

After all, U.S. investors can now choose from nearly 500 ADRs on the New York Stock Exchange and Nasdaq (and another 750 on the pink sheets). And when you consider the vast number of country-specific exchange-traded funds (ETFs), and regional mutual funds at your disposal, you realize we’re spoiled for choice. 

The 10,000-Foot View
Before you go in search of specific stocks or funds, you need to focus on the big picture.

A crucial investing theme — which has benefited Embraer, Honda and so many other firms — is a view of where various countries and regions are in their growth cycle. I’ve written many times about the dynamic nature of emerging-market middle classes, which are roughly at the point where the U.S. consumer class was in the 1950s.

Let’s use Africa as an example. The African middle class has tripled in size over the past three decades, and the continent likely has the “fastest-growing consumer class in the world,” according to Ernst & Young.

That’s not to say that investors should solely focus on African consumer goods and services. A broad array of businesses is needed to ultimately support the growing cadre of firms that directly serve the middle class.

One of my favorites is Steinhoff International (OTC: SNHFY), which operates a variety of businesses across Africa and other emerging markets. But Steinhoff trades on the pink sheets, which means that trading volumes are low, and investors will need to call their broker (online or otherwise) to make sure they are getting solid trade execution.

Many investors don’t want that hassle. They’re probably better off focusing on what are known as sponsored ADRs, which have a full listing on the NYSE or Nasdaq, and also tend to have much higher trading volumes. Software giant SAP (NYSE: SAP), for example, is a sponsored ADR and trades nearly 1 million shares a day on the Nasdaq.

Another route to great emerging-market growth stocks is through funds. In my travels, I have been impressed by Chilean firm Falabella, a fast-growing retailer throughout the western part of South America. Back in 2005, Falabella had $3.7 billion in sales. That figure soared past $11 billion last year, and based on the company’s expansion plans, double-digit sales growth seems baked in for the foreseeable future.

But U.S. investors are precluded from buying shares of Falabella, unless they have access to a brokerage account that can buy stocks on local stocks exchanges. But Falabella also happens to be the top holding for the iShares MSCI Chile Capped ETF (NYSE: ECH). That ETF also holds a number of other local companies that are profiting from fast-growing consumer class in the Andean nations.

Risks to Consider: Emerging markets tend to be more volatile, so the time-tested caveat of longer-term time horizons needs to be reiterated.

Action to Take –> U.S. portfolios have ample exposure to great companies such as IBM (NYSE: IBM), Coca-Cola (NYSE: KO) and Wal-Mart (NYSE: WMT). Trouble is, such companies are no longer growing as they once did. Instead, the real action lies outside U.S. borders. As a general rule of thumb, the less developed any particular market, the greater the growth prospects. That’s why you need to make sure your portfolio has exposure to Africa, Latin America and Asia. All of which are on the same growth trajectory seen by the U.S. and Europe in the decades after World War II.

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