Valuing companies in emerging markets requires more than just applying the usual models. The numbers may look great—strong revenue growth, rising margins, and attractive market potential—but investors don’t just price companies based on fundamentals. They also price in risk. And in emerging markets, country risk and currency volatility play a major role.
These risks affect everything from the cost of capital to cash flow predictability. Ignoring them can lead to overvaluation. Overcompensating can scare off investment. The challenge is knowing how to adjust your valuation framework to reflect the reality of operating in a riskier, less stable environment.
In this article, we’ll break down how country risk and currency concerns are factored into valuation models. You’ll learn how they impact discount rates, how to handle local vs. foreign currency projections, and why two identical businesses—one in Brazil, one in Germany—can have very different values.
Country Risk Premiums and the Cost of Capital
The most direct way country risk shows up in valuation is through the cost of equity—specifically, the country risk premium added to the traditional CAPM formula.
In developed markets, the cost of equity is usually based on:
Re = Risk-Free Rate + Beta × Market Risk Premium
But in emerging markets, you add an extra component:
Re = Risk-Free Rate + Beta × Market Risk Premium + Country Risk Premium
This country risk premium accounts for political instability, legal uncertainty, inflation risk, capital controls, and weak institutions. You can estimate it by looking at sovereign bond spreads, credit ratings, or equity volatility differentials.
For example, a company in Turkey might face a country risk premium of 5% or more, while one in Chile might only face 2%. That difference alone can raise the discount rate and significantly lower the DCF valuation—even if the underlying business is just as strong.
The takeaway:
The higher the perceived country risk, the higher the return investors demand—pushing down the present value of future cash flows.
How Currency Risk Affects Valuation Models
In emerging markets, currency volatility can be just as impactful as country risk. Exchange rates don’t just affect revenue translation—they affect real cash flows, cost structures, investment returns, and investor perception.
There are two key challenges practitioners face when building valuations in these markets:
1. Local vs. Hard Currency Forecasting
You need to decide whether to build your model in local currency (e.g., BRL, MXN, ZAR) or in a hard currency like USD or EUR. Each option has trade-offs.
- Local currency models capture operational reality more accurately—revenues, costs, and taxes are incurred locally. But they require assumptions about future exchange rates to convert the terminal value and equity value back to USD.
- Hard currency models are more investor-friendly (especially for foreign investors), but they can obscure local inflation and distort margins unless carefully adjusted.
Whatever choice you make, the key is consistency: your discount rate must match your cash flow currency. If your DCF is in BRL, your WACC must reflect BRL-based risks. If your model is in USD, you need to adjust local inputs to reflect real, dollar-based outcomes.
2. Inflation and Real vs. Nominal Rates
Emerging markets often experience higher inflation, which complicates long-term cash flow projections. If your cash flows are nominal (including inflation), your discount rate must also be nominal. If they’re real (inflation-stripped), the WACC must be real too.
Many mistakes happen here. Using real discount rates on nominal cash flows—or vice versa—can lead to significant overvaluation or undervaluation.
The takeaway:
Currency assumptions aren’t just translation tools—they’re valuation drivers. Getting them wrong creates silent distortions that compound over time.
Why Identical Businesses Trade at Different Multiples in Different Countries
You could take two companies with the same revenue, EBITDA, growth rate, and margins—one operating in a stable, developed market, the other in a volatile emerging economy—and find that they trade at very different valuation multiples. This isn’t a market inefficiency. It’s a reflection of risk pricing.
Investors pay lower multiples in riskier countries because they expect:
- Higher discount rates (to compensate for uncertainty)
- Lower predictability of cash flow realization
- Greater vulnerability to political shifts, regulatory changes, or currency shocks
For example, a telecom company in Germany might trade at 8× EBITDA, while a similar telecom in Nigeria trades at 4–5×. Even if their operational profiles are nearly identical, investors discount the Nigerian business more aggressively due to higher sovereign risk, capital access issues, and currency exposure.
This affects not just public market valuations, but also M&A deal pricing. Acquirers price in the political and financial stability of the operating environment, and that shows up in the multiples they’re willing to pay.
The takeaway:
Multiples aren’t just about company quality—they reflect country-level risks that shape how value is perceived and priced.
Closing Thoughts
Valuation in emerging markets is never just about the company—it’s about the context in which that company operates. Country risk premiums and currency volatility aren’t optional details to tweak at the end of a model. They are fundamental forces that shape investor expectations, capital flows, and transaction pricing.
The same valuation methods—DCF, Comps, Precedents—still apply. But they must be adjusted with discipline. That means using the right cost of capital, modeling currency exposure realistically, and understanding how political and economic risks flow through to cash flow and return expectations.
A strong business in a high-risk market can still be a great investment—but only if the valuation reflects the real risks involved. The job of the practitioner is to bridge the local story with global capital expectations—and to price uncertainty as carefully as they model growth.