It’s been a good 12 months for SATS Ltd’s (SGX: S58) shareholders with the food catering giant’s shares having gained 22% over the period. But, why did that gain come about? 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…
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
We can track the reasons for SATS’s stock price movement by noting down 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.
I have summarised how SATS’s EPS, PE ratio, and stock price have changed compared to a year ago:
Source: Google Finance; Earnings Report
We can observe that SATS’s higher stock price can be traced back to a combination of increases in both its EPS and PE ratio.
In SATS’s last reporting quarter, that is the first-quarter for the financial year ending 31 March 2016 (FY15/16), it had delivered a mixed bag of numbers. While quarterly revenue fell by 4.2% year-on-year, earnings actually rose a strong 18.4%. The higher earnings may have been welcomed warmly by the market.
Meanwhile, there have been positive developments with SATS. In August, the company announced that it will be providing airmail consignment handling services to Singapore Post Limited (SGX: S08) via a new automated facility that’s named the SATS eCommerce AirHub.
The current outlook for SATS thus appears to be more promising. This, in addition to higher earnings, may have resulted in the market’s increased optimism over SAT’s future (as alluded to by the higher PE ratio).
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 just a gift from the stock market. 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 company mentioned.