Key insights
- Analysis suggests focusing on quality growth companies in emerging markets, defined by high ROE, cash generation, and earnings growth, can outperform the MSCI Emerging Markets Index. However, dilution risks, particularly in China, and increased competition can impact returns. TSMC is highlighted as a prime example of consistent compounding.
Investing.com -- A consistent focus on quality growth companies in emerging markets has delivered positive returns relative to the MSCI Emerging Markets Index over the past decade, though performance has been uneven, according to an analysis by Rob Brewis, Director and Investment Manager at Aubrey Capital Management.
Brewis defines quality through three metrics, return on equity, cash generation and earnings growth, arguing that from a universe of several thousand companies, only a small proportion consistently achieve a return on equity threshold of around 15%.
Mid-teens earnings growth and internally generated cash flows, rather than external financing, complete the framework.
"Companies that rely heavily on borrowing or repeated equity issuance often end up diluting shareholders, whereas those that can reinvest their own cash flows tend to compound more effectively," Brewis said.
The risks of dilution are most visible in China, where aggregate corporate earnings have grown strongly over two decades but earnings per share have grown much more slowly, a gap reflecting new listings, capital raising and state-driven dilution that has reduced gains for minority shareholders.
Excessive returns carry their own risks. Varun Beverages saw returns rise sharply following expansion into southern India and improvement of underperforming assets, but that success drew competition, including from Reliance Industries, making the market more challenging and causing returns to begin normalising.
By contrast, Eicher Motors, owner of the Royal Enfield brand, has maintained consistently robust returns over time through brand strength, despite cyclical pressures from regulatory changes and pricing dynamics.
Taiwan Semiconductor Manufacturing Co. offers what Brewis describes as the clearest example of steady compounding, combining consistent growth with high cash generation and strong returns across cycles.
"Rather than maximising short-term profitability, it has tended to focus on long-term relationships and capacity investment, which in turn has reinforced its competitive advantage," he said.
In China, CATL’s position in the electric vehicle battery market, combined with strong cash generation, allows heavy reinvestment while maintaining a leading competitive position, Brewis noted.
The strategy has faced headwinds. Over the past year, companies with these characteristics have underperformed the broader market, partly due to a difficult period for India, a prolonged slowdown in China and elevated valuations. Periods in 2016, 2022 and parts of 2025 saw similar underperformance.
"What is perhaps more relevant is that, in many cases, valuations have adjusted while underlying fundamentals remain intact," Brewis added, noting returns remain strong, cash generation robust and balance sheets generally holding net cash positions rather than leverage.
The composition of emerging markets has also shifted, with South Korea and Taiwan now exhibiting characteristics closer to developed economies, while China and India remain central to the broader growth story.
Performance has improved more recently, though volatility remains a feature of the asset class, Brewis said.