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SBS Transit Ltd’s Shares Are Up 28% in 1 Year: Here’s What Happened

Land transport services provider SBS Transit Ltd (SGX: S61) has seen its shares rise by 28% in price over the past year.

Why did that happen?

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 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.

Coming back to SBS Transit, here’s a table showing the changes in the company’s EPS, PE ratio, and share price over the past year:

2016-10-18-sbs-transit-stock-price
Source: Google Finance; company’s earnings report

So, SBS Transit recorded 11% growth in EPS over the past year. The higher EPS was supplemented with a bigger increase in its PE ratio of 15%. The combination of the two forces led to the 28% increase in SBS Transit’s share price that I mentioned earlier. The higher PE ratio suggests that investors have gotten more optimistic about SBS Transit’s prospects over the last 12 months.

One possible reason could be the change in SBS Transit’s business model for its public bus business. A new bus contracting model (BCM) had kicked into effect on 1 September 2016.

Under the BCM, the Singapore government will own bus infrastructure such as depots, buses, and fleet management systems. Bus operators will be contracted and paid a fee to operate bus services while the government will retain the fares collected.

But, we will have to wait to see how this new model will translate into SBS Transit’s financial figures in the coming quarters.

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.