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 sinking giant and a simple framework Vehicle distribution giant Jardine Cycle & Carriage Ltd (SGX: C07) has seen its shares drop by 27% in a year. What has happened here? Is the fall for the right or wrong reasons? To help with this, I would like to defer…
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 sinking giant and a simple framework
Vehicle distribution giant Jardine Cycle & Carriage Ltd (SGX: C07) has seen its shares drop by 27% in a year. What has happened here? Is the fall for the right or wrong reasons?
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
To make sense of Jardine Cycle & Carriage’s decline, we can track changes in simple but important financial metrics like its earnings per share (EPS) and price to earnings (PE ratio); these numbers could also be a simple way for you to track the progress of any company over time and can form part of your investment journal entries.
In the table below, I have summarized changes in Jardine Cycle & Carriage’s EPS, PE ratio, and stock price compared to a year ago:
Source: Google Finance; Earnings Report
As you can see, a combination of a lower EPS and PE ratio have weighed on Jardine Cycle & Carriage’s stock price, causing a drop of almost 28% over the last 12 months.
The market’s increased pessimism (alluded to in the lower PE ratio) toward Jardine Cycle & Carriage seems to be warranted given the double-digit decline in earnings. It’s been a tough first-half of the year for the company. For the period, revenue and profit had fallen by 13% and 16% respectively. A weak Indonesian economy and a depreciating Indonesian rupiah (especially against the US dollar; Jardine Cycle & Carriage reports in the US dollar but conducts most of its business in Indonesia) had been big culprits.
But there are still positives here. For instance, Jardine Cycle & Carriage had managed to generate a healthy free cash flow of US$662.8 million in the first six months of 2015. The presence of free cash flow could be important, as the company ended the first half of 2015 with a US$4.32 billion net debt position.
Meanwhile, Jardine Cycle & Carriage continues to be a market leader in its important Automotive business. In the first half of 2015, the company’s share of the wholesale market for cars and motorcycles in Indonesia came in at 50% and 67%, respectively.
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.