First Resources Ltd’s Shares Are Flat Over the Past Year: What’s Next?

The current share price of palm oil producer First Resources Ltd (SGX: EB5) is essentially unchanged compared to a year ago.

Why may that be the case?

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 a stock’s price (or lack of movement in the case of First Resources) is deserved or undeserved.

Deciphering the moving pieces

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.

You can see how First Resources’ EPS, PE ratio, and stock price have changed over the past year in the table below:

Source: Google Finance; Earnings Report; Fx rate (USD to SGD): 1.39

As you can see, First Resource’s EPS has fallen by 43% over the past year. But, its PE ratio has climbed by nearly 75% over the same period to compensate for the lower earnings.

Said another way, First Resouces’ earnings has gone down, but its PE ratio has moved up, cancelling the effect of a decrease in earnings. A higher PE ratio also suggests that investors might have grown more optimistic about the company over the past year.

In its latest quarter (quarter ended 30 June 2016), First Resources recorded lower sales volumes, but enjoyed higher palm oil prices. The net effect was a 14% year-on-year increase in quarterly revenue and a 4.4% increase in EPS. But, First Resources also recorded negative free cash flow –  that’s something investors may want to keep an eye on.

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.