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, Walgreen
Walgreen shares returned 16% over the past decade. How'd they get there?
Dividends accounted for most of it. Without dividends, shares returned about 5% over the past 10 years.
Earnings growth was surprisingly strong over the period. Walgreen's normalized earnings per share grew at an average rate of 13.8% over the past 10 years. For an industry as famously unforgiving as retail, even in a niche market like drug stores, that's impressive. Competitors CVS Caremark
Yet if earnings were so strong, why were shareholder returns so low? This chart explains it:
Source: S&P Capital IQ.
Walgreen's P/E ratio declined by more than 70% over the past 10 years. That's simply incredible. Every bit of Walgreen's earnings growth has been discounted by the market through lower valuations.
Of course, this was because shares were overvalued 10 years ago. At 40 times earnings in 2001, investors were practically guaranteeing themselves a miserable decade, which is exactly what they received.
Going forward, the situation should be quite different. At 11 times earnings, Walgreen shares now look reasonably valued, if not cheap. That could turn the tables: over the past decade, earnings grew, but returns were held down by contracting valuations. Going forward, earnings should continue to grow, but shareholders may enjoy expanding valuations.
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 Walgreen to My Watchlist.