Singapore Exchange Limited’s Shares Have Gained 11% Over The Past Year: What’s Next?

Singapore’s stock market, as represented by the Straits Times Index (SGX: ^STI), has fallen by 5% over the past year. But, not every stock has had a bad 12 months. Bourse operator Singapore Exchange Limited (SGX: S68) is one company whose investors are likely happy given that its shares are up 11% over that period.

What can investors expect from Singapore Exchange going forward?

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 gain

We can track the reasons for the movement of Singapore Exchange’s stock 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 a company over time and can form part of your investment journal entries.

In the table below, you can see how Singapore Exchange’s EPS, PE ratio, and stock price have changed compared to a year ago:

2015-10 SGX Table

Source: Google Finance; Earnings Report

We can observe how the rise in Singapore Exchange’s stock price can be attributed mainly to its growing earnings.

In the fourth-quarter for its fiscal year ended 30 June 2015 (FY2015), Singapore Exchange had recorded strong growth in both revenue and earnings. The former had jumped by close to 25% while the latter was not far behind with a 24.3% rise. The majority of SGX’s revenue growth came from its derivatives segment.

At the moment, the outlook for Singapore Exchange looks promising and  this may be reflected in the higher PE ratio that the company is sporting right now. For context, the PE ratio for the SPDR STI ETF (SGX: ES3), an exchange-traded fund which mimics the fundamentals of the Straits Times Index, has a PE ratio of around 12.

But, some caution may still be warranted here. As Chief Executive Officer Loh Boon Chye noted in Singapore Exchange’s fourth-quarter earnings release:

“Uncertainties in the Chinese market could influence our Derivatives trading volumes, and increasing competition from global exchanges will affect our financial results over time.”

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 due to 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.