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SME IPOs key to growth

Investors share a laugh as they monitor stocks at the Dubai Financial Market. Improved expectations about corporate earnings is the main reason for the increase in the value of the DFM general Index. — Reuters

Major UAE stock exchanges such as the Dubai Financial Market (DFM), Nasdaq Dubai and the Abu Dhabi Securities Exchange (ADX) play an important role in attracting investments into businesses whose stocks are traded on these exchanges, according to a recent Dubai Chamber of Commerce and Industry study.

In its analysis about the investment prospects in Dubai and global stock markets in light of the recent strong performance of major stock indices, the study further states that the UAE’s strong economic growth has been accompanied by growth in value of stocks traded on UAE stock exchanges as the value of stocks traded on the Dubai Financial Market (DFM) in the year 2000 was about Dh437 million, while in the first three quarters of 2013 it shot up to Dh107,863 million.

Recent performance

In the long-term, growth in company earnings per share leads to an increase in the value of stock prices while strong economic growth not only increases stock prices but also the company’s earnings per share.

Additionally, research by experts has shown that investors may realise above market stock returns as long as they can buy stocks when valuations are cheap. In the short and medium term, improved investor expectations about future company earnings and increase in equity indices of major economies are some important reasons for the increase in the value of the DFM General Index.

In this regard, the performance of stock indices of major economies has had a positive impact on the DFM’s performance. This is partly because increased globalisation has allowed funds to move across economies more quickly thus increasing equity market correlations.

For example, the US stock index, the S&P 500, has shown strong increase of about 162 per cent from March 3, 2009 to November 8, 2013. The strong performance of the US stock market is partly due to improvement in the future expectations of investors about company earnings and the need for investors to earn a lucrative return on investment.

These positive expectations in major stock markets are also transmitted across to stock markets in the UAE, partly contributing to the strong performance of the DFM General Index, says the study.

Future opportunities

Stocks remain the major source for investment returns for long-term investors as well as the future earning power of the business, its sustainable competitive advantage and the price paid for the investment. In this regard, investors could find potentially lucrative investments in the DFM in sectors ranging from consumer staples to telecommunications.

Consumer staples, banks and telecommunication have relatively high earning yields. With the UAE population and economy projected to grow over the long-term, strong businesses in these sectors could hold potentially lucrative investment opportunities. The consumer staples sector also has lowest P/E in the list of sectors which could indicate that the investors could get good value for their long-term investment.

The future performance of DFM stocks is also likely to be partly impacted by company earnings and partly due to changes in global equity markets. As mentioned earlier, global equity markets, such as the S&P500, have shown strong performance. While many other scenarios are possible, this strong performance could be expected to continue for some-time, however, investors should then prepare themselves for a possible market correction in major global equity markets, which occur from time to time.

For investors with cash buffers, these corrections in global markets could bring potentially lucrative long-term investment opportunities. One notable long-term growth opportunity in the DFM, and major global markets, could be in publicly listed companies producing consumer and luxury brands.

Strong branding gives businesses a competitive advantage over other businesses and investment in these strong brands could yield potentially profitable long-term investment opportunities as growth in developing regions across Asia, Africa and South America coupled with strong demand from affluent developed economies creates long-term growth in demand for quality branded products. Potential businesses considered for investments could include those involved in producing consumer goods, consumer retail, transport and luxury products.

Managing the risks

The study points out that investment in equities could lead to potentially lucrative returns but could also contain some risks. Examples of some risks include the risk that interest rates increase in major economies over the long run, which may increase the cost of credit for businesses. Another risk is a correction in the major global market indices, which may lead to reduced stock prices.

Company specific risks include increased competition from other businesses and changes in the ability of businesses to grow by increasing their sales and profits. Probably the best way to manage these risks is to buy stocks in a diversified portfolio of quality companies when their prices are low, for example after a market correction, invest with a long-term horizon.

Diversification will help mitigate company specific risks while buying stocks when prices are low will help reduce the impact of future corrections due to rising interest rates or a global economic downturn.

Another challenge is in projecting future earnings, because the value of a business is partly determined by its future earning power. Potential retail and institutional investors could conduct relevant market research about a company’s products, potential for future growth of sales in existing regions and prospects for expansion in new regions.

Also, companies that are consistently successful in gaining market share and which remain focused on their area of expertise could be sound long-term investments. Lastly, holding a cash buffer could also help investors take advantage of market corrections to buy quality businesses at lower prices.

Conclusion

As Small and Medium Enterprises (SMEs) make up an important part of modern economies, making it easier for them to list their shares using IPOs could help SMEs gaining access to a key funding source. Promoting the growth of SMEs in this way could therefore help in the economic growth of the UAE.

Given the growth of the population and increasing per-capita incomes in the UAE, there is a need to increasingly use both local and global equity markets for generating returns needed for asset management funds and individual investors as sound and well considered investment decisions could help make Dubai’s equity markets an important source of long-term investment and wealth creation for the country’s investors, concludes the study.