Why UAE stocks remain an outstanding buy

Investment flows can behave in bizarre ways. Typically for example the enthusiasm of investors for a new asset class will lead them to ignore another, allowing it to become seriously undervalued.

This appears to be what has happened with UAE stocks. Small and large investors have rushed into local real estate in the past 18 months, fuelling a massive construction boom with some $30 billion worth of projects under way. And in the process they have forgotten about investing in local stocks.

Step back for one moment and consider this: if $30 billion of construction, equivalent to almost half the annual GDP, is underway in the UAE what does that mean for local business? It does not matter if you are supplying potatoes or IT equipment, business is going to rocket.

That means local company profits will soar upwards, and with them local share prices. This has happened to some extent. The UAE is the second best performing Arab stock market after Qatar over the past 12 months.

However, a gain of some 28-32% - depending on which index you follow - still leaves share valuations lower than they were a year ago because profit rises have been so good.

A current UAE stock market yield of 3.5% and a 16.5 price/earnings ratio means that shares have some way to rise just to match valuations a year ago. Now with share trading presently at double its level a year ago - admittedly just before the war in Iraq - that gap should be quickly closed.

The question then is how far investors will want to drive the market up. The Amlak Finance flotation's outstanding success, with a mind-boggling 33-times oversubscription, surely shows that investors have an appetite for UAE stocks.

Perhaps if the 97% of the $3.75 billion that unsuccessfully chased shares in the Amlak flotation is put back into the local market then we shall start to see a stock market performance more in line with the economic boom now in progress in the UAE.

For the Executive Office in Dubai has slated $50 billion in real estate projects by 2010, and Abu Dhabi is starting to allocate serious sums to new projects with global giants like Bovis Lend Lease coming into the market, quite apart from the huge expansion of the oil and gas sector.

Alongside Qatar, the UAE is probably uniquely placed for growth over the next five years, and that should take local stock prices a lot higher than they are today.