A Brief History of Occidental Petroleum'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, Occidental Petroleum (NYSE: OXY).

Occidental shares returned a staggering 831% over the past decade. How'd they get there?

Dividends pulled some of the weight. Without dividends, shares returned 649% over the last 10 years.

Earnings growth was incredibly strong. Occidental's normalized earnings per share grew at an average rate of 14% per year from 2001 until today. Other oil companies like ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) saw earnings surge over the period, but not as fast as Occidental. Former CEO Ray Irani was the subject of all kinds of controversy -- most of it justified -- for being one of the highest-paid executives in the world, but one thing is unmistakable: While Irani was paid like a king, he delivered kingly results.

But earnings growth alone doesn't explain Occidental's 831% return over the last decade. Have a look at the company's valuation multiple:

Source: S&P Capital IQ.

Occidental's P/E ratio has doubled over the last 10 years. That's pushed shareholder returns well ahead of earnings growth. Put simply, the market is willing to pay more for each $1 of earnings today than it was in the past.

Just don't expect that to last. At 12 times earnings today, shares aren't exactly expensive, but investors shouldn't expect valuations to keep expanding. The driver that fueled returns over the last decade -- valuations moving from cheap to reasonable -- no longer exists. Going forward, returns over multiyear periods are likely to roughly match earnings growth. There's still the potential for good results, but nothing like the last decade.

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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