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:
- Dividends.
- Earnings growth.
- 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, United Technologies (NYSE: UTX ) .
United Technologies shares returned 240% over the past decade. How'd they get there?
Dividends accounted for a good chunk of it. Without dividends, shares returned 182% over the past 10 years.
Earnings growth was strong during the period. United Technologies' normalized earnings per share grew at an average rate of 12% a year from 2001 until today. That's well above the market average, and highlights the fact that the U.S. government makes up a large chunk of the company's business. Having a large customer who is impervious to budget restraint can be a wonderful thing.
But one of the most important drivers of United Technologies' returns over the past decades is summed up in this chart:
Source: S&P Capital IQ.
United Technologies' valuation multiple has stayed in a tight range over the past decade. Very few large-cap companies can say that. Most started out grossly overvalued in 2001, and have therefore produced meager shareholder returns ever since, even as earnings grew. General Electric's (NYSE: GE ) P/E ratio, for example, fell by around 50% over the period; General Dynamics' (NYSE: GD ) by about the same amount. That's chilled shareholder returns, and it can be entirely blamed on starting out with high valuations.
United Technologies didn't have to deal with compressing valuation multiples simply because shares were cheap 10 years ago. The good news is that shares still seem reasonably valued, and so returns going forward -- say, the next decade -- shouldn't disappoint either.
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.
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