How to Evaluate Companies in Emerging Markets

Last Updated on May 21, 2021 by MoneyVisual

The whole world is more connected to each other than ever before. The advancements in technology & science, from all corners of the world economies, have become independent. Emerging markets and business and advanced economies are now easily reachable to consumers & investors by developed countries.

In fact, many of the mutual fund managers and investors encounter the common problem that how to evaluate a company properly which can do their business in emerging market economies.

In this guide, we will look at the points that should be considered before placing the value or evaluate the emerging markets.

Better use Discounted Cash Flow Analysis for Evaluation

It might seem too difficult to place a value on an emerging market firm, but it is not really too difficult to evaluate a company form a developed country. The strength of evaluation is still DCF (discounted cash flow analysis). The purpose to use this method is to simply calculate how much money an individual investor would get back from an investment.

Even if the subject is the same, there are few factors that may still specific to deal with the emerging market. For example when you are analyzing the emerging market firms that these are some serious concerns like the effect of exchange rates, inflation, and interest rates.

Most of the analysts don’t give importance to the exchange rates, although the local currencies of emerging market nations can be large in relation to the dollar, they seem to stay close to the country’s PPP (purchasing power parity).

So domestic business may be less affected by the changes in the exchange rate in an emerging market firm. Inflation can be a game-changer on evaluation, particularly when a firm operating in probable high inflation settings.

It is very important to calculate future cash flow in both the manner nominal and real terms in order to survive the impact of inflation on a discounted cash flow estimate for an emerging market firm.

Accommodation for estimating DCF in Emerging Markets

Cost of Capital – It plays a major role to estimate the free cash flow in emerging markets. Cost of debt and the firm’s equity cost is more challenging to calculate in emerging markets. The risk-free rate is very difficult to estimate in the emerging markets. Even the government bonds cannot be taken as riskless investments.

Cost of Debt – By using the spreads that are comparable in case of determining the cost of debt from a developed country. The myth which considers that in emerging market risk-free rate is not free of risk. In fact, to select a perfect capital structure, it is good practice to use the industry average. In case there is no local average available using a global or regional average may give the result as well.

Calculated Average Cost of Capital

There is some difficult rule to choose the nation risk premium. In fact, sometimes individual investors will overestimate the premium. A good practice to calculate the average cost of capital is the historical returns of that company’s stocks is considered.

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Peer Comparison

At last but not least evaluating most of the companies from developed nations compare the firm to the industry peers on multiple bases. Estimating the company against a similar type of emerging market firms on multiple bases.