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QAF Limited’s Shares Are Up 19% in 1 Year: Here’s What Happened

Over the past year, shares of food producer and distributor QAF Limited (SGX: Q01) has seen its stock price climb 19%.

Why is that so?

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 QAF, I have summarized changes in the company’s EPS, PE ratio, and stock price over the past year:

2016-10-25-qaf-stock-price-change
Source: Google Finance; company earnings report

During the period above, QAF recorded 39% growth in EPS. But, that was partially offset by a fall in the PE ratio.  The lower PE ratio also suggests that investors have gotten more pessimistic with QAF’s prospects over the last 12 months.

One possible reason could be QAF’s recent deconsolidation of one of its Malaysia-based subsidiaries, Gardenia Bakeries (KL) Sdn Bhd or GBKL. QAF sold 20% of its GBKL shareholdings in April 2016; with that, GBKL ceased being a subsidiary of QAF and became a joint venture. The sale was done to meet Malaysian regulatory requirements.

In its last reporting quarter (the second-quarter of 2016), QAF recorded lower revenue, but sharply higher profits.

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.