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Strategy for 2014: Income or Growth?

The Motley FoolCentral bankers from some of the world’s biggest economies have indicated that interest rates are unlikely to rise anytime soon. Ben Bernanke, the head of the US Federal Reserve has said that the target for the federal fund rate is likely to remain near zero for a considerable time.

Mark Carney, the governor of the Bank of England has indicated that the UK needs sustained low interest rates. Even in the face of a frothy UK housing market, Carney is likely to keep interest rates on hold. Elsewhere, Mario Draghi, who has only just cut interest rates in the Eurozone, is unlikely to raise them any time soon.

Meanwhile, western economies are showing signs of growth. The US economy grew at an annual pace of 2.8% based on the third-quarter numbers this year. Growth, it would seem, was lifted by improving exports, a revival in housing and businesses restocking their warehouses and shelves. The revival prospects for the US economy have even prompted the US Federal Reserve to start winding back its money-printing activities.

In the UK, the economy is expected to grow around 1.4% this year and 2.3% next year. The outlook for economic growth in the Eurozone still looks a little fragile. Nevertheless, the European Commission expects growth to be around 1.1% next year and 1.7% the year after.

The mixed picture for major western economies poses an interesting problem for investors everywhere: should their focus be on income or growth next year?

In times of low interest rates, dividends are likely to become even more attractive for income seekers. After all, bond yields and interest on savings accounts are unlikely to provide lucrative income streams.

Currently, the yield on short-dated 2-year US Treasuries is just 0.3% and 2-year Gilts are yielding less than 0.5%. By comparison, almost every company in the Straits Times Index (SGX: ^STI) has yielded more than those short-dated government bonds. Some of the more attractive dividend payers include Singapore’s largest telecom company SingTel (SGX: Z74) and aero engineer SIA Engineering (SGX: S59). Other generous dividend payers include telecom and media outfit StarHub (SGX: CC3) and property company CapitaMall Trust (SGX: C38U).

Whilst a focus on yield might appear attractive if interest rates remain low, it could be a mistake to dismiss the prospects for growth altogether. An economic cycle is, after all, precisely that – a cycle. Consequently, the time to look for companies that could benefit from an upturn in the economic cycle is before the growth has actually taken place.

Notable companies include banks that tend to do well when the economy recovers. Currently, DBS (SGX: D05), United Overseas Bank (SGX: U11) and Oversea-Chinese Banking Corporation (SGX: O39) are valued at between 9 and 12 times historic earnings. By comparison, the market is valued at around 13 times earnings.

The outlook for retailers might also improve as global economies return to growth too. That is because consumer spending is a significant contributor towards a country’s economic growth. So, as consumer confidence improves, so too should consumer spending. Some of the likely beneficiaries could include the many shopping-related Real Estate Investment Trusts such as Lippo Malls Indonesia Retail Trust (SGX: D51U) and Suntec REIT (SGX: T82U).

When looking at opportunities in the market, it is often easy to pigeon-hole companies into either income or growth. However it is important to remember the total return that investors enjoy is made up of both dividend income and capital appreciation. Both are equally important for investors who have an eye on the long term.

Consider, for instance, SingTel . Over the last ten years, it has delivered a total return of 200% to shareholders. In other words, an investment in SingTel would have nearly trebled over the last decade. But what is interesting is that both capital gains and dividend income have played equally important roles in generating the total returns.

The upshot is that whether you are looking for income or growth or income, the two can be inextricably joined at the hip when it comes to total returns.

A version of this article first appeared in the Independent on Sunday.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.