Despite constant attempts by analysts and the media to complicate the basics of investing, there are only three ways a stock can create value for shareholders:
- 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, Dell (Nasdaq: DELL ) .
Dell shares returned a 49% loss over the last decade. How'd they get there?
The company doesn't pay a dividend, so you can scratch that off the list.
Earnings growth was remarkably strong. Dell's normalized earnings per share grew at an average rate of 11.6% a year from 2002 until today. That's around double the broader market average, and frankly an incredible result for any company to achieve. There's no question about it: Dell's earnings have been a huge success over the last decade.
But if earnings were so strong, why were shareholder returns so horrendous? This chart explains everything you need to know:
Source: S&P Capital IQ.
Dell was grossly overvalued a decade ago. Ten years of falling valuation multiples ever since have prevented all of the company's earnings growth from turning into shareholder returns. That's an important distinction to make: Dell's rotten returns over the last decade were fueled by overvaluation in the past, not a deterioration of its earnings.
The good news is that, at less than 10 times earnings, Dell shares actually look like a fairly good value today. While the past decade has seen valuations contract, the coming decade could see stable, even expanding valuations, helping more of the company's earnings growth turn into shareholder returns.
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.