Why Have SembCorp Marine Ltd’s Shares Fallen by 44% in 1 Year?

Shares of oil rig builder Sembcorp Marine Ltd (SGX: S51) have sunk by 44% in price over the past year.

What’s going on?

A simple framework

To help answer the question above, 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 returns can be made out entirely of the investment return component, entirely of the speculative return component, or a mixture of both components.

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.

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.

Coming back to Sembcorp Marine, I have summarised changes in the company’s EPS, PE ratio, and share price over the past year in the table below:

Source: Google Finance; company’s earnings report

Sembcorp Marine has not had a happy year. The company’s trailing EPS turned negative, which caused its PE ratio to move below zero as well. Given the losses, it’s perhaps no surprise to see Sembcorp Marine’s share price fall by over 40%.

Sembcorp Marine’s latest reporting quarter (quarter ended 30 June 2016) had very little signs of growth.

The company’s quarterly revenue had slumped by 25% year-on-year while its profit had tanked by a whopping 90%. The rig builder also had a net debt position of around S$3.01 billion, nearly double the net debt position of S$1.65 billion seen in the previous year.

SembCorp Marine had slashed its interim dividend as well, from S$0.04 per share a year ago to S$0.015 per share. One area of growth for Sembcorp Marine is its operating cash flow; the financial number had stepped up from a negative S$359 million in the second-quarter of 2015 to a positive S$30 million.

The company does not expect things to improve in the near term. Management commented in the earnings release that “more offshore exploration and production projects have been curtailed” and “capital investments in oil & gas are significantly down.”

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 as a result 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.