Investment products distribution platform operator iFast Corporation Ltd (SGX: AIY) was listed back in December 2014 with a share price of $0.95. But right now, its share price is some 11% lower than during its initial public offering (IPO). What happened? A simple framework To help with 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,…
Investment products distribution platform operator iFast Corporation Ltd (SGX: AIY) was listed back in December 2014 with a share price of $0.95. But right now, its share price is some 11% lower than during its initial public offering (IPO).
A simple framework
To help with 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 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 iFast, here’s a table showing changes in the company’s EPS, PE ratio, and share price since its IPO:
Source: Google Finance; company’s earnings report
We can observe that iFast’s EPS has fallen by almost 50% since its listing. The firm’s PE ratio has moved up to offset some of the fall, but the nett result is a stock price that has drifted 11% below its IPO price.
This raises a question: Is there a reason why iFast’s PE ratio is holding up at a higher level?
For one, iFast left its dividend unchanged in 2016 in its recent fourth quarter earnings announcement. The dividend was maintained despite volatile market sentiment having hampered the company’s revenue growth. In 2016, iFast’s revenue declined by 5.6%; higher expenses sent the company’s profit down even further.
The firm said that it recorded higher amortisation of intangible assets and depreciation to support its business expansion plans. Staff costs were also higher due to the increased number of staff for its new China operations. Said another way, iFast is spending more (leading to lower profit and EPS in 2016) in order to expand its business.
For context, the PE ratio for the SPDR STI ETF (SGX: ES3), an exchange-traded fund which mimics the fundamentals of the Straits Times Index (SGX: ^STI), has a PE ratio of around 13.3. With a PE ratio of over 40 today, iFast’s business will have a lot to live up to in the coming years.
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.