Is DBS Singapore’s indispensable stock?

WHEN interest rates were low, many assets had lofty valuations. 

Using a lower discount rate to value future earnings results in a higher stock valuation. Applying a lower capitalisation rate to projected income leads to a rise in a property’s value.

Moreover, fuelled by cheap debt, businesses could binge on acquisitions to boost profits. And investors could juice up levered returns on investment by borrowing more.

While debate rages over when and by how much interest rates will fall, what appears likely is that interest rates for the years ahead will be much higher than in much of the recent past.

Blame this on stubbornly high inflation, fragmentation of supply chains, rising protectionism, military conflicts, higher defence spending and the cost of transiting to cleaner energy.

High inflation

Investors face tough challenges. Getting returns that beat inflation is difficult with higher inflation. Achieving strong nominal returns is tricky when applying higher discount rates to value assets.

Over a 10-year period to end-March 2023, state investor Temasek chalked up annual total shareholder return (TSR) of 6 per cent. Temasek’s investments include listed and unlisted equities in diverse sectors and geographies.

Going forward, if the investment environment is tougher, might Temasek struggle to achieve TSR in the mid-single digits?

Maybe an individual investor who buys a diversified basket of equities today should expect an annual return, over a multi-year time frame, in the low-to-mid single digits from a mix of dividends and share price appreciation. Such a return may be only slightly better than placing monies in Treasury bills (T-bills) issued by the Singapore government or Singapore dollar fixed deposits.

Yet, individuals urgently need to invest to ensure retirement adequacy, given rising life expectancy and higher inflation.

Might concentrating on an investment winner instead of diversification help?

Sure, concentration risk exists. One might put everything into a business that goes into structural decline due to changes in the market. One may hold a stock whose price collapses because the company’s business hits a bad patch and cannot meet financial obligations.

Perhaps, when investing for the long term in a high inflation and high interest rate environment, one can mix taking concentrated positions in listed equities with holding significant amounts of T-bills and fixed deposits.  

With the aim of trying to outperform equity indices by picking a carefully selected handful of stocks for the riskier side of one’s portfolio, I thought hard as to which single Singapore-listed stock to own for the next two decades or more. My choice is DBS Group .

Where DBS stands to gain

First, size matters. DBS is Singapore’s largest listed company by market capitalisation. With size, a group can offer its customers a wider range of products and services. This helps in broadening and deepening customer relationships.

With size, a group can attract and retain talent by offering good career pathways. Moreover, a large group can find the resources to build strong digital platforms, invest in brand building, try new ideas, manage risks robustly, spend on training and deal with cybersecurity threats. 

Second, banking in Singapore – as in many places – is heavily regulated. In regulated industries, conditions can be more robust for sustainable and long-term profitability, as the number of players could be limited.

Add to that Singapore’s strong reputation in banking regulations. This helps boost the credibility of local banks such as DBS in dealings with customers at home and abroad, as well as overseas regulators.

Third, DBS and its peers OCBC and UOB are exposed to geographic markets with good growth prospects. DBS is focused on Asia, where structural growth drivers remain intact. 

Asia’s growth can be driven by economic giant China as well as fast-growing populous countries with young populations – India and Indonesia.  

Singapore-based banks including DBS can prosper by linking up various Asian markets and by bridging Asian markets with the rest of the world. Also, attracting family wealth from Asia and globally to Singapore creates opportunities for the banking sector here.

Fourth, if recent track record is a guide, DBS could outperform OCBC and UOB. Generally, DBS has been achieving higher return on equity (ROE) than its peers. Between 2019 and 2023, DBS’ ROE averaged 13.6 per cent. In four out of these five years, ROE was in the double-digits.

DBS’ management is confident of achieving ROE of 15 to 17 per cent over the next three to five years. Drivers include faster growth among its high-ROE businesses, such as wealth management and global transaction services.

Should DBS consistently generate strong ROE, shareholders can expect sustainable growth in profits and dividends. As it stands, equity investors in DBS receive a decent dividend yield.

Fifth, ensuring DBS is well run, generates sound returns and rewards shareholders is a matter of national importance as the bank is a key portfolio company of Temasek. 

Temasek’s performance benefits Singapore through the net investment returns contribution (NIRC). Under the NIRC, the government can spend up to half of the long-term expected investment returns generated by the entities that manage Singapore’s reserves, such as Temasek.

Sixth, while higher interest rates hurt many businesses by reducing profit margins, higher rates do not hurt and instead possibly help lenders such as DBS. This is provided borrowers do not default on loans due to economic weakness.

Aided by higher interest rates, as well as the use of artificial intelligence to strengthen the review and monitoring of credit, major banks here can possibly maintain reasonably robust net interest margins and minimise bad loans.

Being insufficiently diversified in one’s equities investments may sound scary. However, being diversified could mean that positive returns generated by good investments are dragged down by duds.

Maybe one should overcome the psychological barrier of taking a concentrated position. After having done due diligence, one ought to boldly invest in one or two stocks where one has strong conviction. Having faith in DBS may yield big rewards.

The writer owns shares in DBS. This column reflects his personal views and should not be construed as investment advice.