Profit From the Growing Global Middle Class

LONDON -- One of the big investment themes over the next couple of decades is going to be the rapid increase in the number of middle-class consumers in the developing world. We've seen what happens when countries like Japan, Singapore, South Korea, and Taiwan transform their economies: They end up with a large middle class with Western levels of income and a strong desire for consumer goods. Now, many other countries look set to emulate their growth.

So it's likely that countries such as Brazil, China, India, Indonesia, and even some African nations will be in a similar position in a generation or two. As consumers in these countries already like to buy Western-branded goods, this trend looks set to continue. So why not get a piece of the action?

Quality products and strong brand names
One of the keys to selling to aspirational consumers in the developing world is to have a good product. Western companies have a big advantage here because of the generally lower quality of most domestic brands in the developing world.

A good example of the importance of branding can be seen in how China's consumers responded to the baby milk scandal of 2008, where several products were deliberately contaminated with melamine, resulting in six deaths and hundreds of thousands of sick babies. Many were put off Chinese brands as a result and turned to foreign brands.

Think global, stay local
An easy way to invest in companies that sell to consumers in the developing world is to look at British companies that already have a strong presence there. My personal favorites are the FTSE 100 (INDEX: ^FTSE) giants Diageo and Unilever (NYS: UL) , both of which have a long history in these markets.

Unilever already makes more than half its sales in the emerging markets, and it expects this to rise to three-quarters by 2020. It has been a major player in India for more than 80 years through its majority-owned subsidiary Hindustan Unilever, so it already has a big slice of the Indian market.

As you can see from its most recent quarterly management statement, Diageo's fastest-growing markets are in South America and Africa, where sales rose by 18% and 12%, respectively, which more than makes up for a 1% fall in sales within the sclerotic eurozone.

Another increasingly popular product in the emerging-market nations is tobacco, and if I were happy about investing in tobacco -- I'm not, on moral grounds -- then my portfolio would be heavily weighted toward tobacco via the likes of British American Tobacco and Imperial Tobacco.

A few more companies
It's not too hard to find some other British companies, both large and small, with emerging-market interests. I tend to be biased in favour of consumer goods companies with strong brands, such as PZ Cussons, which is best-known for its Imperial Leather range of soaps, and for which Africa is a much bigger market than Europe.

But there are also many non-consumer-goods companies with a decent long-term track record in these markets. One of these is the insurance giant Prudential, which generated 44% of its profits last year in Asia -- more than any of its other divisions.

A very fast-growing sector in the emerging markets is mobile telephony. But rather than getting involved in the handset market, where competition is cutthroat, why not instead buy shares in the network providers? One such is Vodafone (NAS: VOD) , which has a piece of the mobile-phone network market in most countries, and whose shares currently sit on a prospective price-to-earnings ratio of 10.9, where their forecast yield is 7.4%.

Don't limit yourself to Britain
As it is quite easy to buy shares on the major foreign stock exchanges, why limit yourself to British companies? After all, some of the biggest players on the emerging-market stage are American companies such as Coca-Cola (NYS: KO) and McDonald's (NSE: MCD).

My No. 1 non-British emerging-market pick is McDonald's biggest competitor, Yum! Brands. You may not know the name, but you've almost certainly heard of its KFC fast-food restaurants -- which have been in China for almost 25 years -- and it looks as if India also has the potential to become yet another big market for Yum!.

The downside is that Yum!'s shares are on a very high historic P/E ratio of 26, though forecasts for the current year cut this to 21, which means that a lot of future growth is already in Yum!'s share price. In contrast, Diageo -- which many investors consider to be expensive -- trades at a P/E of about 18. This comes with the territory; many emerging-market plays are on high P/E ratios precisely because of their growth prospects.

When it comes to supplying tobacco consumers in the emerging markets, the name that stands out is Philip Morris International, which was the non-American arm of Altria until it was spun off in 2008. If, like me, you question the morality of supplying an addictive and highly damaging product to consumers in the developing world, then you won't want to touch these with a barge pole. If not, then I recommend a closer look.

Funds, funds
If you're not happy about investing in individual companies, another way to invest in the emerging markets is via funds such as JPMorgan Emerging Markets or Templeton Emerging Markets Investment Trust.

Many funds like these specialize in domestic companies within the emerging-market nations, rather than Western companies like those mentioned above, making them a nice addition to a diversified portfolio. After all, it's quite possible that consumers will end up preferring domestic brands; though many of these will be bought by the multinationals, just as many "British" brands are now owned by non-British companies.

Either way, consumers in the emerging markets offer investors yet another way to profit over the long term and diversify their portfolios.

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At the time thisarticle was published Tony owns shares in Diageo, Templeton Emerging Markets Investment Trust, Unilever, and Yum! Brands. The Motley Fool owns shares in PZ Cussons. The Motley Fool owns shares of Coca-Cola.Motley Fool newsletter serviceshave recommended buying shares of McDonald's, Unilever, Vodafone Group, and Coca-Cola. The Motley Fool has adisclosure policy.
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