Is It Time To Invest In Russia?

Posted by David Hunkar on 24 February 2013, 10:58 am

Many global investors avoid investing in Russian equities. Despite the country holding democratic elections and the legalization of private property rights since the fall of communism in 1991, Russia remains a pariah for most investors for good reason. Some of the factors that work against Russia include the widely-held beliefs that it violates human rights, jails opponents questioning the state, arbitrarily takes over private enterprises, suppresses the media, arbitrarily prosecutes company executes and throws in prison without due process, etc. The list of factors that one can document seem to be endless. Hence Russia is unable to attract high foreign investment in Russian equity markets like other emerging markets are able to.

Russia will host the 22nd Winter Olympics from February 7th to the 23rd of next year in the city of Sochi. By hosting this high-profile event, Russia hopes to present a positive image to the global investment community. Already investors are warming up to Russian stocks with the benchmark index up 5% YTD.

From a recent article titled Russia’s image problem in the US in FT beyondbrics blog:

Chris Osborne, Head of Sberbank CIB USA, would be the first to admit that Russia has an image problem among American investors.

“Selling Russia can be a challenge,” he told beyondbrics. “For people who are not already investors in Russia, the image of the country is very negative.”

Indeed, despite being the world’s ninth largest economy with a rising middle class that’s driving a boom in everything from car sales to malls to e-commerce and holidays in Spain, Russia hasn’t been getting much love from investors.

Last year Russian equity and fixed income funds attracted a combined $8.8bn of inflows according to EPFR, which tracks fund flows. While this is a leg up from 2011 – when Russia suffered an outflow of $2bn – the amount is still far less than the $12.9bn that investors pumped into Brazilian assets and the $16.5bn attracted by Chinese assets in 2012, according to EPFR.

Composition of Russia’s MICEX Index:

Source: Russia’s image problem in the US, FT beyondbrics blog

As shown above, the Russian equity market is heavily dominated by the energy industry. This is not surprising since the country is blessed with all types of natural resources including crude oil and natural gas. As a result, the movement of Russian stocks is highly correlated to the price of oil.

Source: Diversifying Russia, Harnessing regional diversity, European Bank for Reconstruction and Development

The Russian stock market appears to be dirt cheap as per an article in Canadian Business magazine. From the article:

For years, money has shunned the country, mostly because of uncertainty. There’s always a threat of nationalization, a sudden tax hike, arbitrary executive prosecutions and weird policies such as forbidding Americans from adopting Russian orphans.

Those fears, paradoxically, have made the country incredibly attractive from a value perspective. The Russian stock market is currently trading at around 5.5 times earnings, barely half the price-to-earnings ratio of other emerging markets. “It seems logical that a market trading that cheaply doesn’t have a lot of downside,” says Michael O’Flynn, the Massachusetts-based managing director and global head of business development for UFG Asset Management. A decade ago, Russia was trading at a 50% premium to its Brazil, one of its BRIC peers; today it trades at a 50% discount.

That discount could easily diminish. For starters, the events that most spooked investors are fading from memory. The state takeover of Yukos, a massively successful oil company, happened a decade ago. Former CEO Mikhail Khodorkovsky may be out of prison by Olympic time.

Russia’s middle class is growing too—and the country’s GDP per capita is about US$18,000, much higher than that of other emerging markets. There’s also been talk of privatizing government assets, which “foreign investors should be applauding,” Elena Shaftan, manager of the Jupiter Emerging European Opportunities Fund, wrote in a recent report.

Source: The Russian bear turns bullish, Canadian Business

Investors looking to add exposure to Russia can consider adding stocks in the consumer and manufacturing sector due to the rising middle class and growing consumption. The energy sector is highly volatile and can be avoided. However Chris Osborne, Head of Sberbank CIB USA quoted in the FT beyondbrics article that not many companies in the consumer and industrial sector are listed and hence investing in those sectors is a challenge.

The best way to invest in Russian equities is via the Market Vectors Russia ETF (RSX). This fund has about 42% of the assets in the energy sector.However investors can access the consumer staples, consumer discretionary industrials and other sectors with this ETF. The two consumer sectors and the industrials account for about 7% and 1.3% respectively The asset base of the fund is $1.6 billion which is low relative to the assets held by other emerging market country-specific ETFs such as iShares’ Brazil ETF (EWZ) with assets of over $9.0 billion.

Investors who prefer to buy individual Russian stocks in any sector can consider the following five companies. These firms trade on the OTC market and were the largest traded depository receipts in 2012 according to a report by BNY Mellon:

1.Company: Gazprom (OGZPY)
Current Dividend Yield: 6.28%
Sector: Natural Gas Producers

2.Company: Lukoil (LUKOY)
Current Dividend Yield: 5.60%
Sector: Oil & Gas – Integrated

3.Company: Rosneft(OJSCY)
Current Dividend Yield: No regular dividends paid
Sector: Oil & Gas – Integrated

4.Company: Norilsk Nickel(NILSY)
Current Dividend Yield: 6.84%
Sector: Metal Mining

5.Company: Sberbank(SBRCY)
Current Dividend Yield: 1.78%
Sector: Banking

Note: Dividend yields noted are as of Feb 22, 2013

Disclosure: No Positions

Comparing U.S. Tax Revenues To Other G-7 Countries

Posted by David Hunkar on 24 February 2013, 5:13 am

For the Fiscal Year 2012, the total U.S. Federal Spending was about $3.8 Trillion and the Tax Revenue was about $2.5 Trillion resulting in a deficit of about $1.3 Trillion. For many years now, the U.S. has been running deficits as revenues were lower than expenditures. In fact, expenditures have been soaring due to rising medicare costs and other programs but revenues have barely moved up in pace.

From January 1, 2013 thirteen tax increases went into effect as part of the deal struck between the Obama administration and Congress according to The Heritage Foundation. These include the social security tax component of payroll taxes rising to 6.2% from 4.2% for all Americans, top marginal tax rate jumping to 39.6% from 35.0%, taxes on capital gains and dividends rising from 15 to 20% for taxable incomes over $450,000 for joint filers, a 3.8% surcharge on investment income for taxpayers with taxable income of over $250,000 for married filers, etc.

Though all these tax increases seem high and thousands of hours were wasted by politicians debating the issues as part of the Fiscal Cliff negotiations late last year, they are actually lower compared to taxes paid by citizens of other G-7 countries.

The following chart shows the U.S. government taxes by revenue source as a measure of GDP in 2010 relative to other G-7 countries:

Click to enlarge

Source: US in Debtors’ Prison: A Life Sentence? by Emanuella Enenajor and Andrew Grantham, Economic Insights, January 29, 2013, CIBC World Markets

The total U.S. tax revenue was at at least 10% lower than the average of other G-7 countries. Except corporate taxes, the U.S. collected lower taxes in the other sources noted above compared to other G-7 countries.

According to the CIBC research report, Japan plans to implement a new sales tax in the years ahead to increase tax revenues. However in the U.S. sales taxes on goods and services are controlled and collected by the individual states and no national sales tax such as Value Added Tax(VAT) exists in the country. In fact, the U.S. is the only developed country which does not have a national-level sales tax. As a result of this archaic tax system, each state behaves like a separate country constantly manipulating the tax rates mostly to finance all types of local boondoggles such as tax subsidies for casinos, stadiums, construction of parking garages, park renovations, etc.

Equity Investing for the Very Long Term Will Yield Spectacular Returns

Posted by David Hunkar on 23 February 2013, 10:16 am

I wrote an article last week discussing about the strategy of investing in stocks during a crisis for great returns. This post is a follow up to that article but takes on the benefits of investing in equities for the very long-term. Very long-term can be defined as a time period measured in decades.

From Reasons to Avoid Buying Stocks, and Why You Should Ignore Them in The New York Times:

THERE are always reasons not to buy stocks. Investors may think the Dow Jones industrial average is too high, as was the case in 1954 when the index topped 360. In 1941, there was Pearl Harbor. In 1962, the Cuban missile crisis. In 1997, the Asian financial crisis.

The list, adding up to 78 for each of the years from 1934 to 2012, was compiled by Bel Air Investment Advisors.

But the punch line to this list was that stocks went up by an annual compounded rate of 10.59 percent over those 78 years, with occasional plateaus, and that $1 million invested in 1934 was worth $2.4 billion in 2012.

Click to Enlarge

Source: Reasons to Avoid Buying Stocks, and Why You Should Ignore Them, The New York Times

Data Source: Bel Air Investment advisors

The return calculated in this study based on the S&P 500 is indeed astonishing. Similar studies in the past have shown great returns as well. Here is one chart from the fourth edition of famous book Stocks for the Long Run by Professor Jeremy Siegel of The Wharton School.

A $1 invested in 1801 would have been worth $12.7 million according to his analysis. So investing in equities for the very long-term will yield spectacular returns.

However for most investors this strategy will not work for many reasons. For example, most investors do not hold stocks for many decades. Since very few of us live past the age 100, the idea of investing for centuries is ruled out. Despite these flaws, reviews of the benefits of long-term investing are interesting to follow. While investing for the very long-term is not feasible for most investors, it is a wise idea to hold equity investments for at least five years. One way to do this would be to build a diversified portfolio of dividend-paying well-established companies and reinvesting dividends and other earnings to take advantage of compounding.

Related ETFs:

iShares MSCI Emerging Markets Index (EEM)
Vanguard Emerging Markets ETF (VWO)
SPDR S&P 500 ETF (SPY)
SPDR STOXX Europe 50 ETF (FEU)
SPDR DJ Euro STOXX 50 ETF (FEZ)

Disclosure: No Positions

A Review of Bloomberg BusinessWeek 50

Posted by David Hunkar on 23 February 2013, 1:05 am

Bloomberg BusinessWeek recently published its annual ranking of the top 50 U.S. companies. From the article:

The Bloomberg Businessweek 50 ranks companies on how well they’ve done and how well analysts expect them to do. Half of the ranking is based on past performance: their stocks’ risk-adjusted returns over one and five years. The other half is based on outlook: analysts’ recommendations and forecasts for earnings growth. Companies at the top of the list have both strong track records and high expectations from Wall Street for growth ahead.

Here is the chart showing the BBW50 for 2013:

Click to enlarge

Source: Breaking Down the BBW50, Bloomberg BusinessWeek

A cool interactive chart can be found here.

The top 3 firms in terms of revenues are Apple(APPL), McKesson(MCK) and CVS CareMark(CVS) in descending order. However the top 3 firms based on market caps are Apple(APPL), Amazon(AMZN) and Comcase(CMCSA). In terms of Earnings Per Share the top 3 firms are Apple(APPL), Priceline.com(PCLN) and Mastercard(MA).

Five interesting names investors can consider for further research are:

1.Company: Airgas Inc (ARG)
Current Dividend Yield: 1.66%
Sector: Chemical Manufacturing

2.Company: Mastercard(MA)
Current Dividend Yield: 0.46%
Sector: Consumer Financial Services

3.Company: McKesson(MCK)
Current Dividend Yield: 0.78%
Sector: Biotechnology & Drugs

4.Company: Union Pacific Corp (UNP)
Current Dividend Yield: 2.06%
Sector: Railroads

5.Company:Ecolab Inc (ECL)
Current Dividend Yield: 1.24%
Sector: Personal & Household Products

Note: Dividend yields noted are as of Feb 22, 2013

Disclosure: No Positions