5 Companies That Doubled Earnings While Their Stocks Went Nowhere

I couldn't for the life of me track down the actual quote, but Peter Lynch once said something along the lines of, "The biggest mistake an investor can make is buying the right company at the wrong price. Because then the company does well, but the stock goes nowhere."

How right he was! Most investors have lost money over the past few years. But what really caused these losses? Was it a deterioration of companies and their earnings power, or just a reevaluation by markets? There's a major difference between the two.

Consider these five companies, all of which have doubled (or nearly doubled) earnings in the past four to six years while their stocks went nowhere.

1. Microsoft (Nasdaq: MSFT  )
In 2004, Microsoft earned $0.75 a share. Over the past year, it pulled down $2.10 per share. That's 18.7% earnings growth per year. Extraordinary. Yet Microsoft shares trade lower today than they did for all of 2004. Dividends provided some return, but shareholders have essentially been handed a donut for a company that's blown the lights out on earnings.  

2. Google (Nasdaq: GOOG  )
Google shares have gone precisely nowhere since late 2006. The company, however, has been on a tear. Revenue has more than doubled since 2006. Ditto for earnings per share, which have jumped from $9.94 to $23.03. That's 23% annual earnings growth, for which investors were rewarded with bupkis.

3. Wal-Mart (NYSE: WMT  )
Wal-Mart's business has famously done well during the recession as consumers flock toward frugalism. Earnings per share have nearly doubled since 2004, from $2.03 to $3.91. Yet during this same period, shares have flatlined.

4. Johnson & Johnson (NYSE: JNJ  )
In 2005, J&J earned $2.74 per share. Over the past year, it nearly doubled that, to $4.84 per share. The company also almost doubled its dividend payout during this period. Its shares? They trade lower today than they did for most of 2005.

5. WellPoint (NYSE: WLP  )
WellPoint is the strongest example of this group. In 2006, the company earned $4.82 per share. Over the past 12 months, it's made $11.23 per share. Yet during this four-year period, the company's shares have fallen 28%. Incredible.

I made a point here of staying within a four-to-six-year timeframe. Stretching this exercise out to 10 years brings you back to dot-com bubble territory, where examples of companies growing earnings while their stocks pooped out becomes the norm.

Why does this happen? There are three explanations for why a company's earnings can explode while its stock languishes:

  1. The current valuation is too low.
  2. The starting valuation was too high.
  3. Future growth prospects have suddenly taken a nosedive.

The recent period of dismal returns probably owes somewhat to all three factors. But the first two -- the valuation issues -- deserve the lion's share of your attention.  

At a conference I recently attended, value investor Vitaliy Katsenelson made a great point: History shows that the single most important statistic in determining market returns is not GDP growth, interest rates, or even earnings growth. It's starting valuations. Start with high valuations, and future returns will be poor, even if companies and the economy boom. Start with low valuations, and future returns can be great, even if companies simply trod along. That's the point Lynch was making as well.

So where are we now? It's not hard to make the case that current valuations for these companies -- and most large caps, for that matter -- are indeed low. Microsoft, for example, trades at about eight times earnings after backing out its cash hoard. Johnson & Johnson's dividend yield is 3.5% -- far higher than 10-year Treasuries -- and it's grown that dividend payout by more than 12% per year for the past 30 years. Wal-Mart trades at 12 times forward earnings, despite having the most powerful retail moat known to mankind. There's no way to describe these numbers as anything other than outrageous. They're simple reflections of investors extrapolating previous poor results into the indefinite future.

There are two important parts to successful investing: finding the right company, and finding the right price. In any market, singling out good companies isn't terribly difficult. They're usually well-hyped. But finding the right price can be painfully elusive. Thankfully, the pool of good companies selling at good prices today is about as deep as it's been at any time during the past decade.

For past 10 years, strong companies provided abysmal stock performances. Over the next ten, I have a feeling  that mediocre companies will start providing strong stock returns. These things move in cycles.           

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Google, Microsoft, WellPoint, and Wal-Mart Stores are Motley Fool Inside Value selections. Google is a Motley Fool Rule Breakers recommendation. Johnson & Johnson is a Motley Fool Income Investor selection. Motley Fool Options has recommended diagonal call positions on Johnson & Johnson and Microsoft. The Fool owns shares of Google, Microsoft, and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Morgan Housel owns shares of Microsoft and J & J. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (20) | Recommend This Article (137)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 17, 2010, at 6:25 PM, rgperrin wrote:

    An "explanation" does answer "why" (that's what makes an explanation an explanation), so it is not necessary to refer to an "explanation for why." Follow?

  • Report this Comment On September 17, 2010, at 8:24 PM, JustHanginOut wrote:

    Huh? An explanation can also be for how or what (as in, "can you explain what this is"). Follow? A reject from the German National School of Grammar.

  • Report this Comment On September 17, 2010, at 11:53 PM, Hotpicks101 wrote:

    haha wow you just owned rgperrin. By the way nice article.

  • Report this Comment On September 18, 2010, at 1:11 AM, joenobody101 wrote:

    Dividend is king ! I cannot live on how great the company is and will be. Show me the money ( into my pocket from time to time ).

    All these great companies pay so little in way of dividend no wonder their stock prices lag.

    So many GREAT companies out there, so little capital to invest. I opt for dividned paying ones..................

  • Report this Comment On September 18, 2010, at 4:09 AM, mtracy9 wrote:

    "Any growth stock that sells for 40 times its earnings for the upcoming year is dangerously overpriced and in most cases extravagant." (BtS" p.63) "In 1972, McDonald's was the same great company it had always been, but the stock was bid up to $75 a share, which gave it a P/E of 50. There was no way that McDonald's could live up to those expectations, and the stock price fell from $75 to $25, sending the P/E back to a more realistic 13. There wasn't anything wrong with McDonald's. It was simply overpriced at $75 in 1972." --Peter Lynch

    http://shouldersofgiantsinvestor.com

  • Report this Comment On September 18, 2010, at 9:33 AM, daeby wrote:

    Wellpoint earnings may be up, but they offshored many American jobs to get there. Many dedicated US citizens, some with three decades or more of service, replaced by less skilled, low pay workers in other countries. At least the CEO did well, with her 51% raise. Sometimes values other than price and earnings are important.

  • Report this Comment On September 18, 2010, at 10:21 AM, gldmn1and2 wrote:

    Please clarify. According to ValueLine, WLP earned $4.79 in 2006 and over the past 12 months, it's made $6.03 (9/09 - 6/10). Even if you meant the fiscal year 2009, earnings were $4.95. They split in 2005. Could you have inadvertently not factored that in or somehow used their annual common share reductions since then? When looking at these numbers, you would certainly change your conclusions.

  • Report this Comment On September 18, 2010, at 10:32 AM, TMFHousel wrote:

    gldmn1and2,

    Thanks for your comments. All the data in this article comes from Capital IQ, a division of Standard & Poor's. The values are correct. The period you mention, 9/09 - 6/10, is only 9 months. Earnings in FY '09 were $9.88, which you can see on page 44 of this filing:

    http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?F...

    The $11.23 mentioned in this article represents the 12 months ended June 30, and is derived by $5.07 billion in net income divided by 446 million shares outstanding.

    Thanks,

    Morgan

  • Report this Comment On September 18, 2010, at 11:18 AM, TLassen wrote:

    Good article TMFHousel

    Could you run a correlation between the EPS growth rates and the corresponding Stockholder equity growth rates.

    One should assume as a company grows its accounting earnings the stocholder value would grow at the same rate. Or else it might just be smoke and mirrors?

    I know for JNJ the 10-year CAGRs are 'in-line', what about the other companies?

  • Report this Comment On September 18, 2010, at 12:57 PM, bigkansasfool wrote:

    Good article. You have to buy good companies at GOOD PRICES. Too many people forget that second part. I'd love to own Google and Apple, but google has a P/E of 21.21 and apple has a P/E 20.74. Those P/E already assume very good growth, meaning they're not good values.

  • Report this Comment On September 18, 2010, at 2:05 PM, nahid wrote:

    I have very little money to get into something that is very high risk. as much as i would like to secure my old age, which is now.

    receive invitation for all these new programs at the fools.

    I think it is really for someone half my age who still has time to recoup losses.

    pistoo

  • Report this Comment On September 18, 2010, at 2:16 PM, nietzschesport wrote:

    So what's everyone's fav out of this group? I'm sticking with JNJ. I appreciate the Fools article yesterday on JNJ. Also, there was a great analysis about JNJ as undervalued at http://gregspeicher.com/ if anyone's interested.

    "Our goal is double-digit growth every year ... between 9% to 10% every year,” said the JNJ exec

    http://nietzschesportfolio.blogspot.com/

  • Report this Comment On September 18, 2010, at 4:42 PM, TLassen wrote:

    "Good article. You have to buy good companies at GOOD PRICES. Too many people forget that second part. I'd love to own Google and Apple, but google has a P/E of 21.21 and apple has a P/E 20.74. Those P/E already assume very good growth, meaning they're not good values"

    and you are buying AAPLs 35% ROE at 5 x Book Value so you are only getting 7% earnings yield, seems like a lot of future growth is already priced in.

  • Report this Comment On September 18, 2010, at 4:55 PM, DrRonPaul4Prez wrote:

    When I see strong, growing companies such as these mentioned whose stock price has remained flat over the course of the past several years, I interpret that as a good thing! To me, that says that the buying opportunity is still there for those not already in. As value continues to be added to shareholders, it will only be a matter of time until a higher price is demanded for the stock.

  • Report this Comment On September 18, 2010, at 5:32 PM, MashkiaTsair wrote:

    Please add "Western Digital" (WDC) -- A computer Hard-Disk manufacturer -- Company trades at P/E=4.5 and P/B=1.3, and it's stock did not move since 2006 !!!

    Company is very stable financially, and grows at 30% y/y CAGR. (EPS)

    This is my top pick.

    Disclosure: Long WDC.

    -MashkiaTsair

  • Report this Comment On September 18, 2010, at 5:50 PM, DaGecko wrote:

    I think the quote your are trying to recall may be from One Up On Wall Street. "Buy the right stocks at the wrong price at the wrong time and you'll suffer great losses,"

    Is that the one?

  • Report this Comment On September 20, 2010, at 10:43 AM, financeguy85 wrote:

    Very nice article. I believe the conundrum described here falls into the category of "multiple contraction". As far as a stock price is concerned, it really doesn't matter if a company is increasing earnings if the market isn't willing to pay as much for each dollar.

  • Report this Comment On September 24, 2010, at 1:24 PM, shaileshnita wrote:

    This is a brilliant piece of work. It is a very good investigation that underscores the fact that the stock-performance is a complex issue. No single approach, formula or procedure fits all.

    I am really impressed by the person who chose this subject and presented before us in such a simple manner. Thank you.

  • Report this Comment On September 24, 2010, at 4:31 PM, erkaye wrote:

    Liked the article, but got lost at the end. What mediocre companies do you reference in the last paragraph? Do you mean JNJ, MSFT, etc?

  • Report this Comment On September 24, 2010, at 7:21 PM, chat01 wrote:

    So basically we're are back to the old joke:

    How do I get a good return on my investment?

    Well if I was you I wouldn't start from here! (Or in this case I WOULD start from here).

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