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M1 Ltd’s Shares Have Dropped by 16.4% in One Year: What Happened?

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 telecommunications outfit M1 Ltd  (SGX: B2F) as an example. You can see how the company’s EPS and PE ratio have changed over the past year in the table below:

2015-09 M1 Table

Source: Google Finance; Earnings Report

As you can see, the 16.4% decrease in M1’s stock price had been caused by a 21.2% fall in its PE ratio which has taken place despite a respectable 6.1% increase in its EPS. This is fairly similar to what M1’s compatriot Starhub Ltd (SGX: CC3) had experienced as well over the past year.

For M1, the stock market appears to have grown pessimistic on its prospects despite the decent financial performance.

One reason for the pessimism could be the fall in service revenue which M1 reported in its recent quarter. As the source of recurring revenue, there could be cause for concern if this trend continues.

Elsewhere, the balance sheet for M1 also weakened. The telco ended 2014 with a net-debt position of S$279.2 million but that number had climbed to S$311.2 million as of 30 June 2015. The possible entry of a fourth telco into the Singapore market, which may pose a threat to M1’s existing business, may have also weighed on the stock price.

Foolish takeaway

With all the above in mind, the Foolish investor may be in a better position to judge whether the current pessimism (in the form of a lower PE ratio) for M1’s future 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 the market’s irrationality. 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.