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:
- 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, Dollar Tree
Dollar Tree shares returned 311% over the past decade. How'd they get there?
The company doesn't pay a dividend, so we can scratch that off the list.
Earnings growth was incredibly strong over the period. Dollar Tree's normalized earnings per share grew by an average of 18.4% a year from 2001 until today -- far above that of Family Dollar Stores
And have a look at the company's valuation multiple:
Source: S&P Capital IQ.
Dollar Tree started out the last decade like most companies: overvalued. That kept shareholder returns low until early 2008, when valuations bottomed out at a dirt-cheap 10 times earnings. Indeed, essentially all of Dollar Tree's cumulative returns of the last decade have occurred since early 2008. Valuations more than doubled over that period, providing shareholder returns that have outstripped earnings growth. This should drive home 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.
- Add Dollar Tree to My Watchlist.
Fool contributor Morgan Housel owns shares of Wal-Mart. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Wal-Mart Stores. 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.