A Brief History of Caterpillar's Returns

Despite constant attempts by analysts and the media to complicate the basics of investing, there are really only three ways a stock can create value for its shareholders:                                                                      

  1. Dividends.
  2. Earnings growth.
  3. Changes in valuation multiples.

In this series, we drill down on one company's returns to see how each of those three has played a role over the past decade. Step on up, Caterpillar (NYSE: CAT  ) .

Cat shares have returned 362% over the past decade. How'd they get there?

Dividends accounted for a good chunk of it. Without dividends, Cat shares returned 265% over the past 10 years.

Earnings growth was strong during the period. Cat's earnings per share have grown at an average rate of 16% per year for the past ten years. That's well above the market average, and impressive considering how much of the global construction market has gone bust since the financial crisis.

And have a look at Cat's earnings multiple:

Source: S&P Capital IQ.

The big P/E ratio spike around 2009 was due to a dearth in earnings that the market (rightly) perceived as being temporary. If you ignore that period and focus on Cat's current P/E in relation to where it was post-crisis, things look fairly stable -- the ratio has stayed in the 15 times to 20 times range for most of the past decade. That's been more or less true for Deere (NYSE: DE  ) as well -- shareholder returns have been high, but earnings multiple has stayed fairly constant.

That's a good sign for shareholders. The high returns generated over the past decade have not, for the most part, been driven by market exuberance. They've been driven by strong earnings growth, which is exactly what you want to see.

Why is this stuff worth paying attention to? It's important to know not only how much a stock has returned, but where those returns came from. Sometimes earnings grow, but the market isn't willing to pay as much for those earnings. Sometimes earnings fall, but the market bids shares higher anyway. Sometimes both earnings and earnings multiples stay flat, but a company generates returns through dividends. Sometimes everything works together, and returns surge. Sometimes nothing works and they crash. All tell a different story about the state of a company. Not knowing why something happened can be just as dangerous as not knowing that something happened at all.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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10/21/2016 4:01 PM
CAT $86.33 Down -0.30 -0.35%
Caterpillar CAPS Rating: ***
DE $86.43 Up +0.32 +0.37%
John Deere CAPS Rating: ***