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, Cummins
Cummins shares have been an extraordinary winner over the past decade, returning 1,310%. How'd they get there?
Dividends accounted for about a third of it. Without dividends, Cummins shares gained 1066% over the past 10 years.
Earnings growth has been gangbusters. It's hard to get a good snapshot of Cummins' earnings-per-share growth over a 10-year period because the company wasn't profitable 10 years ago. Looking at operating earnings, however, gives us some idea: Cummins' operating earnings have grown at an average annual rate of 45% a year for the past 10 years. That's simply incredible, far better than what other industrial manufacturers like Caterpillar
And have a look at Cummins' P/E ratio:
Source: S&P Capital IQ.
There are a few things to take away from this chart. One, the big spike around 2003 was because earnings were negligible as the company slowly entered the world of profitability. Two, even as share prices climbed relentlessly higher, Cummins' earnings multiple never got very high. That's what you want to see: shareholder returns that are driven by earnings, not market exuberance. And shares still look reasonably valued today. At 13 times earnings, there's little reason to worry shares are getting ahead of themselves. That bodes well for returns going forward.
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.
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Fool contributor Morgan Housel doesn't own any of the shares mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Cummins. 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.