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Singapore Telecommunications Limited’s Shares Are Up 6% In 1 Year: Here’s What Happened

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 simple framework

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, a stock’s price return can be made out entirely of the investment return component, entirely of the speculative return component, or a mixture of both components.

Deciphering the rise  

We can track the investment or speculative components of a stock’s return by noting down changes in its financial metrics such as its earnings per share (EPS) and price to earnings ratio (PE ratio). On a related side note, such notes 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.

The last 12 months have seen shares of Singapore’s largest telecommunications company Singapore Telecommunications Limited  (SGX: Z74) inching up by 6%. What has happened here? Below, I have summarized how the company’s EPS and PE ratio have changed over the past year:

2016-09-15-singtel-stock-change
Source: Google Finance; company’s earnings report

The rise in Singtel’s stock price can be traced entirely back to a matching 6% expansion in the PE ratio; in contrast, the telco’s EPS was relatively flat during this timeframe.

Singtel’s higher PE ratio could be a sign that the stock market has grown more optimistic about the company compared to a year ago.

In its last reporting quarter, Singtel reported lower sales due to weakness in its Australian subsidiary Optus. So, there are challenges for SingTel. On the more positive side of things, Singtel could be sitting on a US$2 billion bounty with its stake in Netlink Trust.

Foolish takeaway

If a stock price rises (or falls), we should try to understand if it is backed by a company’s fundamental growth (or decline), or whether it is simply a result of investor exuberance (or 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 something that happened because of luck or the market’s irrationality. Such knowledge can help us with 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.