Why Have Wilmar International Limited’s Shares Risen by Almost 21% 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 move

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, Asian agribusiness conglomerate Wilmar International Limited (SGX: F34) has seen its share price climb by 21%. Let’s use Dorsey’s framework and look beneath the hood.

In the table below, I have summarized changes in the company’s EPS, PE ratio, and stock price over the last 12 months:

Source: Google Finance; company’s earnings report

There is a stark contrast between the movement of Wilmar’s EPS and PE ratio.

While the firm’s EPS has been cut almost in half compared to a year ago, the PE ratio has shot up by some 132% over the same period. This could be a sign that the market is getting more optimistic over Wilmar’s business.

In its latest reporting quarter (the quarter ended 30 June 2016), Wilmar’s revenue barely budged and it actually suffered a loss of US$220.2 million. The firm also had a net debt position of around US$12.2 billion. Despite the loss, Wilmar had left its interim dividend unchanged at S$0.025 per share.

There isn’t much we can tell from the firm’s outlook: Wilmar expects the rest of the year’s results to be “satisfactory.”

Foolish takeaway

If a stock’s 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 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.