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, 3M (NYSE: MMM ) .
3M shares returned 83% over the past decade. How'd they get there?
Dividends pulled about half the weight. Without dividends, 3M shares returned 45% over the past 10 years.
Earnings growth was fairly strong. 3M's normalized earnings per share grew at an average rate of 8.5% per year from 2001 until today. That's well above the market average, and substantially better than other large multinationals such as General Electric (NYSE: GE ) and Honeywell (NYSE: HON ) . Part of 3M's growth was driven by a reduction in the number of shares outstanding, which fell 10% over the period.
But if 3M's earnings were so good, why were returns so bland? After all, earnings more than doubled while shares returned just 83%. This chart explains why that happened:
Source: S&P Capital IQ.
Like so many large-cap stocks, 3M shares were priced for perfection 10 years ago. Valuations spent the better part of the last decade falling back into a more reasonable range, which has prevented part of the company's earnings growth from turning into shareholder returns.
The good news is that, at 15 times earnings, shares look reasonably valued today. With prospects for solid earnings growth still intact, that bodes well going forward. While valuation multiples contracted for most of the past decade, the coming decade could see multiples stay flat or even expand, allowing more earnings growth to materialize into shareholder returns and adding a much-deserved tailwind for patient investors.
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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