Why Has Sarine Technologies Ltd’s Stock Halved in One Year?

There can be good reasons as well as poor reasons for why a stock’s price moves.

For the Foolish investor, understanding the right reason is important. If we can determine the reason, we may get an inkling on whether the movement in the stock price is deserved or undeserved and thus act accordingly.

A simple framework

To help with this, I would like to defer to a couple of paragraphs from The Little Book that Builds Wealth by author and fund manager Pat Dorsey:

“Over long stretches of time, there are just two things that push a stock up or down: The investment return, driven by earnings growth and dividends, and the speculative return, driven by changes in the price-earnings (P/E) ratio.

Think of the investment return as reflecting a company’s financial performance, and the speculative return as reflecting the exuberance or pessimism of other investors.”

Under Dorsey’s framework, stock price returns can be from the deserved-end of the spectrum (investment return), the undeserved-end of the spectrum (speculative return), or anywhere in between.

Deciphering the fall  

We can track the reasons for a stock’s movement by noting down simple but important financial metrics like its earnings per share (EPS) and price to earnings (PE ratio); they could also be a simple way for you to track the progress of a company over time and can form part of your investment journal entries.

Let’s use diamond-manufacturing systems supplier Sarine Technologies Ltd  (SGX: U77) as an example. Below, I have summarized the company’s EPS, PE ratio and the change for each element compared to a year ago:

2015-09 Sarine Table

Source: Google Finance; Earnings Report

As you can see, the 50% decrease in Sarine Technologies’ stock price is closely matched by a 49% decrease in the company’s EPS. The PE ratio, in comparison, was little changed over the past 12 months.

From the above, it would appear that a large part of the stock price fall is deserved.

On the other hand, drastic falls in EPS is not something new for Sarine Technologies. The diamond manufacturing equipment and systems maker had endured similar cuts in earnings during the Global Financial Crisis, only to then see its earnings recover.

In the meantime, the company is looking to new products like Sarine Light and Sarine Loupe to form the third leg of its future growth.

Foolish takeaway

With all the above in mind, the Foolish investor may be in a better position to judge whether the fall in Sarine Technologies’ share price is justified.

If a stock price rises (or falls), we should try to understand if it is backed by a company’s fundamental growth (decline), or whether it is simply a result of investor exuberance (pessimism).

When we understand the difference, we may become a better judge on whether our stock price gains (losses) are justified – with commensurate growth (decline) in earnings – or had happened because of moments of irrationality in the stock market. Such knowledge can then aid us in our decision making while investing.

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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.