Valuation represents only one side of the multilayered decision process behind choosing a stock. Other tangible and less tangible issues, such as, for example, the existence of the earnings momentum, sensitivity to newsflow, and the quality of management, play important roles behind the selection process. Such intangibles have traditionally held more weight in emerging market investment criteria than in developed ones, and continue to do so. This argument naturally pertains to Russia as well, and we argue that valuations can also incorporate intangible considerations.

The RTS is trading at a 2003 P/E of 6.8x, which albeit some 15% higher than at the beginning of the year, still compares favourably with other developing markets. We now take a look at sectors and individual stocks within the Russian investment universe.

The easiest multiple to use is EV/Sales. It is also the least useful of the multiples – the company may have an attractive multiple on a standalone basis, or on a growth-adjusted basis, but nothing would tell us if the company is actually profitable or if it is losing money. One way of avoiding this problem is to compare EV/Sales and Net Margin – clearly the companies with low multiples and high margins are attractive on this scale. Some of the automakers are trading at the lowest multiples, but many of them do not show growth and have low net income margins. Telecom stocks are trading on high multiples, but they are also expected to post the fastest growth and their profit margins are above 15%.

Admittedly, EV/EBITDA is also not the best multiple upon which to focus, taking no consideration, for example, of either taxes or capex. However, given ongoing differences in the reporting standards of Russian companies, EBITDA is frequently the line below which a lot of things go fuzzy. For instance, the Russian Accounting Standards (RAS) – still used by most companies, apart from blue chip stocks with ADRs – treat net income in a very different way from the U.S. GAAP and IAS. It is entirely normal to make social contributions, pay bonuses to employees, or divert funds elsewhere from whatever is called the net income under RAS, and hence RAS reported net income usually shrinks substantially when converted into GAAP figures.

The EBITDA line tends to be less distorted by accounting differences and thus our first step is to focus on it. The average Russian 2003 EV/EBITDA has somewhat increased over the past 5 months and is now about 3.8x, as opposed to 3.2x in January. There are a number of companies, which trade at a substantial discount even to this already low number. However, in most cases, there is a good reason for this – either growth is not there, or the risks are too high. For instance, although many utilities companies are trading at or below 2x EV/EBITDA, the growth is on the low side, but the risks are on the high side. Retailer TsUM shows one of the most impressive growth profiles (37% CAGR in EBITDA), and is also trading at a discount to the average. However, TsUM’s 19%+ weighted average cost of capital (WACC) is substantially above the average, and we are uncertain about its long-term strategy.

PAZ, Wimm-Bill-Dann, Norilsk Nickel, and Baltika are the companies, which, in our view, look appealing on an EV/EBITDA valuation basis, factoring in growth.

TsUM also shows up well on the EV/CF valuation sheet, followed by PAZ. Valuations of Vympelkom, Wimm-Bill-Dann, and Volga Telecom also look quite attractive, once growth is factored in. Tatneft and Surgutneftegas are two of the cheaper stocks by this measure, but there is no growth in Tatneft, while Surgut is no longer trading on fundamentals.

The P/E valuation also highlights the automotive and utilities stocks, and Sberbank, as some of the more attractively valued shares. MTS, Vympelkom, and Wimm-Bill-Dann also look good on growth adjusted measures, albeit that they are trading above the average of 6.8x.

The return on capital employed (ROCE) valuation, which, at least in theory, incorporates all cash items – including taxes, company indebtedness, and capital expenditure – highlights that most of the companies which have positive returns over their WACC have already traded up. Examples are easy to find – YUKOS, Baltika, MTS, Vympelkom, and Sibneft.

The companies which do have a positive spread of ROIC over WACC are LUKOIL, and Zavolzhskiy Motors, and, to a lesser degree, Mosenergo and Norilsk Nickel. While Zavolzhskiy Motors is forecast to keep its ROIC above WACC for the next two years, LUKOIL’s economic returns are forecast to deteriorate in 2004, while those of Norilsk Nickel are expected to improve.