Why Have SembCorp Industries Limited’s Shares Fallen by Over 26% in 1 Year?

The share price of marine engineering and utilities conglomerate Sembcorp Industries Limited (SGX: U96) has fallen by a sharp 26.2% in over the last 12 months.

Why has that happened?

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 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 Industries, 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

It has been a tough year-long stretch for Sembcorp Industries with its EPS crashing by 57% over the last 12 months. Its stock price decline would have been worse if not for a 71% jump in its PE ratio. The higher PE ratio could be a sign that the stock market has gotten more optimistic over Sembcorp Industries’ business fortunes over the past year.

Thing is, Sembcorp Industries’ latest reporting quarter (quarter ended 30 June 2016) did not show much signs of growth.

The conglomerate’s revenue for the quarter had slumped by 22.7% year-on-year while its profit had tanked by a steeper 61%. Sembcorp Industries also cut its interim dividend from S$0.05 per share a year ago to S$0.04 per share. The balance sheet’s net-debt position had increased as well, rising from S$4.1 billion a year ago to S$6.8 billion.

One area of growth for Sembcorp Industries is its cash flow picture. The company ended the second-quarter of 2016 with free cash flow of a negative S$81 million, which is a big step-up from the negative S$700 million recorded a year ago.

Sembcorp Industries also commented in the earnings release that “the current market environment remains difficult.” But, it added that it is expecting better results from its utilities investments in India in the second-half of 2016.

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.

If you want to learn more about investing and to keep up to date on the latest financial and stock market news, you can sign up for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore

Also, like us on Facebook to follow our latest hot articles. The Motley Fool's purpose is to help the world invest, better.

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.