Think long-term - businesses must build a growth, not just a yield, market

ANYONE who was involved in the just-past annual general meeting (AGM) season can attest to how all sorts of shareholders show up. There are the retirees who have one or two lots invested in multiple companies and treat the occasion as a way to pass the time and enjoy some free food. There are the shareholders who ask rambling questions and dominate the stand for half an hour. And there are those who publicly admit that they have not read the annual report in the last five years and they don't know exactly what the company does but they decided to attend this year's AGM because the share price performance has been so dismal.

Across all companies, one theme shines through. Retail shareholders like dividends, and the more the better. It does not matter whether the company is a trader that needs some cash as working capital, a firm investing heavily in emerging markets, or an S-chip with cash in the bank. At AGMs, there will often be at least one investor who will stand up and ask for higher payouts.

The demand for yield is understandable, and not just because these investors are retirees with few other sources of income. A bird in the hand is worth two in the bush, and reinvested dividends can compound over time to form a large part of the total return of a stock. With developed countries around the world facing slower growth, and monetary easing practised by many central banks, low interest rates are also driving the demand for yield.

Singapore has done much to develop a market for yield-hungry investors through its real estate investment trust (Reit) infrastructure. Yet Reits alone cannot be the solution to creating investor wealth. Investors become wealthy because they hold stocks exposed to fast-growing industries or markets, or which maintain a dominant position among their peers. These stocks do end up paying an increasing stream of dividends over the years, but dividends are just a by-product of a superior business model.

There are basic trade-offs between returning capital to shareholders, and reinvesting in growth. Singapore investors have to understand how high dividend yields aren't everything. A high proportion of earnings paid out, for example, can leave a company vulnerable should there be a sudden drop in earnings. Smaller Reits trade at high dividend yields because they contain higher risk. This is due to the lack of a strong financial sponsor, the lack of cheap funding, exchange rate risks, country risks or insufficient diversification.

Unfortunately, investors will always be tempted to go for yield without sufficient scrutiny of the underlying business or investment product. In any public education campaign, investors should be taught to assess stocks based on their earnings potential over a period of time, instead of how much money will be paid over the next year.

Stocks exposed to the business cycle are worth a look in this market climate. Many trade at reasonable valuations given the shift towards defensive yield stocks. Meanwhile, more promising local private enterprises can also be encouraged to list. Singapore's market is known as a yield market, but businesses with growth stories have a place there too.