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 soaring airline and simple framework Singapore’s flagship carrier Singapore Airlines Ltd (SGX: C6L) has seen its shares climb by 9.5% over the past 12 months. It’s a strong performance – that’s especially so when we consider that the Straits Times Index (SGX: ^STI), Singapore’s market barometer, had dropped…
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 soaring airline and simple framework
Singapore’s flagship carrier Singapore Airlines Ltd (SGX: C6L) has seen its shares climb by 9.5% over the past 12 months. It’s a strong performance – that’s especially so when we consider that the Straits Times Index (SGX: ^STI), Singapore’s market barometer, had dropped by 8.7% in the same timeframe – but why had that happened?
Is the rise in Singapore Airlines’ stock for the right or wrong reasons? To help answer 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 understand Singapore Airlines’ share price growth, 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, you can see changes in Singapore Airlines’ EPS, PE ratio, and stock price compared to a year ago:
Source: Google Finance; Earnings Report
I trust that it’s fairly obvious to see how a sharply higher EPS has lifted Singapore Airline’s stock price up by nearly 10% over the past year.
Falling oil prices (the price of the fuel is today around half of what it was at its 2014 peak) have been a bane to the likes of oil rig builders Keppel Corporation Limited (SGX: BN4) and SembCorp Marine Ltd (SGX: S51). But, low oil prices have been a boon for the likes of Singapore Airlines – this is because a huge chunk of the airline’s expenses come from fuel costs (fuel cost has made up an average of 37% of total revenue in Singapore Airline’s past three fiscal years).
Singapore Airlines’ most recent quarter saw its earnings spike by a massive 160% on the back of cheaper fuel. The airline operator also reported close to S$190 million in free cash flow for the first-quarter of its fiscal year (12 months ending 31 March 2016) and a net cash position of S$3.8 billion.
The airline industry has traditionally been a hard industry to operate in, therefore maintaining a net cash position could be important for an airline’s long-term survivability.
Singapore Airlines’ stock price also started with a relatively high PE ratio of 40.7 a year ago. The big spike in earnings has brought down the PE ratio to more palatable levels. That said, the airline is still valued at a premium to the broader market. As of 7 October 2015, the SDPR STI ETF (SGX: ES3) – an exchange-traded fund which mimics the Straits Times Index (SGX: ^STI) – carries a PE ratio of 11.9.
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.