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:
- 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, General Electric
GE shares generated a net loss of 41% over the past 10 years. How'd they get there?
Dividends softened the blow. Without dividends, shares lost 57% over the past decade.
Earnings per share actually declined by 0.6% per year for the past decade. Now, the past 10 years have been a tough time for the economy, but a cumulative earnings loss over the period is exceptionally poor, especially considering that inflation diminished the value of a dollar by 25% over the period. Other large, multinational companies like Siemens
To boot, have a look at GE's valuation multiple:
Source: S&P Capital IQ.
While having rebounded sharply since the depths of the financial crisis, GE's P/E ratio is still about 50% lower than where it was 10 years ago. Part of this is because shares were overvalued 10 years ago; part is because GE Capital, once a profit engine for the company, turned into a liability and pruned the company's earnings prospects; part is because of the global industrial economy slowing down; and part is the possibility that, at 14 times earnings, GE shares might now be reasonably cheap.
That last one is important. Over the past 10 years, shareholders had to deal with compressing valuation multiples. Going forward, it's reasonable to expect expanding multiples, potentially adding a much-needed boost to 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.
- Add General Electric to My Watchlist.
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 3M. 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.