Why Have BreadTalk Group Limited’s Shares Dropped By 7% In A Year?

Popular bakery and restaurant operator BreadTalk Group Limited (SGX: 5DA) has seen its shares decline by 7% over the past year. What’s happened?

A simple framework

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.

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 gain some understanding of BreadTalk’s stock price movement, we can track 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 how BreadTalk’s EPS, PE ratio, and stock price have changed compared to a year ago:

2015-10 BreadTalk Table

Source: Google Finance; Earnings Report

Turns out, the fall in BreadTalk’s shares can almost entirely be attributed to a lower EPS.

The market appeared to still be buoyant over the future of BreadTalk, judging by the unchanged and high PE ratio (more on this later). There may be a good reason for this: BreadTalk’s most recent quarter was a solid one. Quarterly revenue and profit had moved up by 11% and 10% year-on-year, respectively. BreadTalk also clocked in $8.3 million in free cash flow for the quarter, a welcome development compared to the year before when free cash flow was negative.

But, BreadTalk’s latest earnings release also had areas for caution. For instance, BreadTalk had a net debt position of $130.7 million on its balance sheet as of 30 June 2015.

Meanwhile, BreadTalk’s current PE ratio of 27.9 can also be considered to be at a high premium to where the broader market is trading. To that point, the PE ratio of the SPDR STI ETF (SGX: ES3), an exchange-traded fund which mimics the Straits Times Index (SGX: ^STI), is only around 12 now.

Foolish takeaway

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.