A Brief History of Bed Bath & Beyond's Returns

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:

  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, Bed Bath & Beyond (Nasdaq: BBBY  ) .

Bed Bath & Beyond shares returned 75% 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. Bed Bath & Beyond's normalized earnings per share grew at an average rate of 18.5% a year from 2002 until today. That's about triple the broader market average, and a strong performance for any company to achieve, particularly given the weak state of the economy. There's no question about it: Bed Bath & Beyond's earnings have been a huge success over the last decade.

But if earnings were so strong, why were shareholder returns fairly weak? This chart explains everything you need to know:

Source: S&P Capital IQ.

Bed Bath & Beyond was substantially overvalued a decade ago. Ten years of falling valuation multiples ever since has prevented part of the company's earnings growth from turning into shareholder returns. That's an important distinction to make: Bed Bath & Beyond's modest returns over the last decade were fueled by overvaluation in the past, not a deterioration of its earnings.                 

The good news is that, at about 16 times earnings, shares actually look like a decent 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.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Bed Bath & Beyond. 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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