Many high-quality businesses are based in the United States, but that doesn’t mean that investors should focus exclusively there. Emerging markets have been shunned as an asset class because accounting standards are typically less robust and the ETFs used to gain exposure are dominated by industries that don’t generate sufficient excess return on invested capital (ROIC). (Think state oil companies, banks and utilities.)
Since 2003, emerging markets have delivered roughly the ROIC of their firms in total return (I would argue with more risk than developed markets leading to worse risk-adjusted returns). However, this annualized figure is warped by the early influx of capital into the fund when it was introduced, along with peak commodity prices (namely $140/barrel oil) in 2008. Since the 2008 global fiscal crisis, returns suffered from lower commodity prices and no excess economic growth above cost of capital. Below are the annual total returns for investing in 2010 to highlight returns after the fallout from the financial crisis of 2008:
1.iShares MSCI Emerging Markets ETF (EEM) & iShares S&P 500 Annualized Total Return 1/1/2010 – 6/5/2025
If you invested in emerging markets from 2010 on, for the last 15+ years you would have made less than 3% total return annually. This dynamic is why we as a firm have avoided emerging markets entirely for a very long time. However, when looking at companies in emerging markets that offer excess and improving ROIC along with being in a line of business we are fond of, one name stood out as a flower in a field of weeds: Mercado Libre.
What is Mercado Libre?
Mercado Libre (Free Market in Spanish) is essentially the Amazon of Latin America. Based in Uruguay, the company’s operations stretch from Argentina to Brazil to Mexico. Mercado Libre (MELI) has an e-commerce platform and is expanding its offerings to include a robust advertising ecosystem and digital financial services business. All of these are growth areas which allow for reinvestment of earnings to further grow the enterprise. There’s not much difference in evaluating operating fundamentals when scrutinizing emerging market businesses; one universal standard applies. We believe the true margin of safety lies with investing in firms that earn high excess returns on capital, regardless of jurisdiction. Below are some operating fundamentals we’ve observed:
2.MELI 5Y Return on Invested Capital 6/5/25
Mercado Libre steadily increased ROIC over the past five years. Five to seven years ago, the firm made massive initial investments into its digital financial services and advertising platforms, which have now started to pay off. It’s important to determine whether low returns on capital occur on a short-term basis because of higher temporary growth capital expenditures or because the company is in a bad line of business. In Mercado Libre’s case, we’ve assessed it’s the former. In fact, they outearned their cost of capital before these massive investments.
3.MELI 10Y Return on Invested Capital 6/5/25
This dynamic gives us confidence in management’s ability to allocate capital to complementary, value-accretive projects and that those investments that artificially lowered ROIC are now scaling up to be profitable, self-sustaining lines of business that reward investors over the long term. Let’s look at revenue and margins to further evaluate these investments:
4.MELI 5Y Trailing 12 Month Revenue 6/5/25
This is very encouraging. Not only have sales grown sequentially year over year, but revenue grew from $2.8 billion to over $22 billion in five years, while the stock price remained the same until roughly a month ago! When it comes to evaluating the success of capital expenditures, at the very least they will generate incremental increases in revenue alongside the organic growth of the business. However, with revenue growth of +50% annually for the past five years, we see the financial services and advertising initiatives as attractive offerings that brought new customers into their ecosystem. With regards to these initiatives, let’s also evaluate how operating margins have been trending, as growth at the expense of profitability is not sustainable. Here is the operating margin profile:
5.MELI 5Y Operating Margin 6/5/25
Margins have grown since these massive capital expenditure investments were made, though they are still lower than their historical margins pre-investment:
6.MELI Operating Margin Since Inception 6/5/25
So why invest now instead of waiting for even higher margins? First, the record of revenue growth is encouraging because sales growth after the investment initiatives is visible and stable. The second reason is because the concept known as operating leverage.
Operating Leverage
Operating leverage describes the change in profits as margins change. A quick example:
Firm A has 2% operating margins; Firm B has 20% operating margins. Both optimize their operations and see their operating margins increase by 2%. Firm A’s margins increase from 2% to 4% and Firm B’s margins go from 20% to 22%. Firm A’s operating profits double, while Firm B’s increase by 10% (1/10th of Firm A).
Firms with low margins have higher operating leverage because they work from a lower base and vice versa. This is why lower-margin businesses like oil companies or industrial businesses obsess over costs relative to high-margin businesses like software or pharmaceuticals. With improved margins, profits rocket higher, but if margins deteriorate, profits cascade down. This explains why commodity firms with low margins experience such aggressive cycles. However, if operating margins are low, improving, and defensible, profitability may look like this:
7.MELI 5Y Earnings Per Share 6/5/25
When Mercado Libre made its investments five years ago, EPS was $0-1 since all its operating earnings were being reinvested. Now that it has matured, the business realized EPS of over $37 at the end of 2024 and current estimated EPS of over $48 per share this year!
To simplify, a 7-8x increase in revenue combined with a 5x increase in operating margin translates to a 35-40x increase in earnings, which is what you see above. We believe the business has proven its investments are both successful and scalable. Considering the market valuation is the same as it was prior to these lines of business meeting or exceeding expectations, an opportunity to invest at an attractive entry point has presented itself.
What We’re Looking for From Here
To be blunt, more of the same. Operating margins improving from this point won’t cause the same explosion in earnings since they are starting at 12% instead of 2% and it’s easier to go from $2B to $20B in sales than $20B to $200B. However, with the trajectory easier to see and improvements on all fronts of revenue, margins and ROIC, it’s an attractive place to be. Of course, it’s also important to check these trends over time to make sure the company continues to execute. With regards to its focused lines of business in e-commerce, digital payments and optimized advertising, we’re confident that Mercado Libre is positioned appropriately to capture growth in these areas, expand operations and earnings, and lead to outsized returns for shareholders.
SOURCES:
1. YCharts. iShares MSCI Emerging Markets ETF (EEM) & iShares S&P 500 Annualized Total Return (1/1/2010 – 6/5/2025)
2. YCharts: MELI 5Y Return on Invested Capital (6/5/25)
3. YCharts. MELI 10Y Return on Invested Capital (6/5/25)
4. YCharts. MELI 5Y Trailing 12 Month Revenue (6/5/25)
5. YCharts: MELI 5Y Operating Margin (6/5/25)
6. YCharts. MELI Operating Margin Since Inception (6/5/25)
7. YCharts. MELI 5Y Earnings Per Share (6/5/25)
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