Why Are M1 Ltd’s Shares Down By Over 17% in 1 Year?

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 fall  

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.

Over the past year, Singapore’s smallest telecommunications company M1 Ltd  (SGX: B2F) has seen its shares fall by over 17%. Why is that so?

In the table below, I have summarized changes in the company’s stock price, EPS, and PE ratio over the past year:

Source: Google Finance; company’s earnings report

So, M1’s 4% decline in EPS had contributed to its lower share price. But, the bigger contributor is actually the 13.6% fall in its PE ratio. The sharply lower PE ratio could be a sign that the stock market has gotten more pessimistic on M1 compared to a year ago.

In its latest quarter (the second quarter of 2016), M1 lowered its profit-growth guidance to a single digit decline for 2016; in the first quarter of the year, M1 had called out for a “stable performance for the year.” The telco is looking to invest in a portfolio of digital solutions and this will incur up-front costs.

Meanwhile, it’s worth noting too that the Singapore-focused M1 has to grapple with increased consumer adoption of OTT (over-the-top) services and the impending arrival of a fourth telco in Singapore’s market.

Foolish takeaway

If a stock’s price rises (or falls), we should try to understand if it is backed by the 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 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.