SMRT Corporation Ltd’s Shares are Down 17% Over the Past Year: What’s Going On?

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.

We can see how these can be done with land transport firm SMRT Corporation Ltd  (SGX: S53). In the table below, I have summarised how the company’s EPS, PE ratio, and stock price have changed over the last 12 months:

SMRT EPS, PE ratio, and Stock Price table

Source: S&P Capital IQ

SMRT Corporation’s stock price may be down 17% overall, but there are two different tales for its PE ratio and EPS. As you can tell, the former has fallen by some 36.5% while the latter has shown a strong 30.6% increase.

Looking at the numbers, it would seem like SMRT Corporation’s EPS is catching up with the lofty PE ratio that the transport firm was trading at a year ago.

SMRT Corporation’s latest earnings release for its fiscal first-quarter (quarter ended 30 June 2015) saw its EPS contract by 10%. Furthermore, the firm held a sizable net debt position of almost S$700 million and reported negative free cash flow for the quarter. These factors may also have contributed to the lower PE Ratio for SMRT Corporation.

Foolish takeaway

With all the above in mind, the Foolish investor may be in a better position to judge whether SMRT Corporation’s current PE ratio and its price decline over the last 12 months makes sense.

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 a stock’s 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.

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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.