A Brief History of eBay'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, eBay (Nasdaq: EBAY  ) .

eBay shares returned 76% 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. eBay's normalized earnings per share grew at an average rate of 27% a year from 2002 until today. That's almost a magnitude above the broader market average, and frankly an incredible result for any company to achieve. There's no question about it: eBay's earnings have been a huge success over the last decade.

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

Source: S&P Capital IQ.

eBay 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: eBay's mediocre returns over the last decade were fueled by overvaluation in the past, not a deterioration of its earnings.

At nearly 30 times normalized earnings today, shares still don't look terribly cheap. Going forward, far more of eBay's earnings growth will materialize into shareholder returns than in the past, but current valuations still don't leave much room for error, and aren't likely to set shareholders up for remarkable returns going forward. This highlights one of the most important lessons in investing: Starting valuations determine future 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 and writing puts in eBay. 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.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1755393, ~/Articles/ArticleHandler.aspx, 9/18/2014 5:56:09 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement