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Why Have Singapore Technologies Engineering Ltd’s Shares Risen by Over 12% 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 a stock’s 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, stock price returns 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.

In the last 12 months, engineering conglomerate Singapore Technologies Engineering Ltd’s  (SGX: S63) shares have climbed by 12%. Let’s use Dorsey’s framework and dig in further.

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

2016-09-22-st-engineering-price-change
Source: Google Finance; company’s earnings report

ST Engineering’s share price has grown because of PE expansion. The firm’s EPS has barely budged compared to a year ago. In contrast, the PE ratio has increased by around 13%. This could be a sign that the market has become more optimistic over ST Engineering Engineering’s fortunes.

In its latest reporting quarter (the quarter ended 30 June 2016), ST Engineering’s revenue and EPS rose by 5% and 2%, respectively, and it left its interim dividend unchanged at S$0.05 per share.

The firm also reported a net debt position of around $200 million. Although the company expects its revenue for the whole of 2016 to be higher compared to 2015, ST Engineering also expects its pre-tax profit to be lower.

Foolish takeaway

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