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, Eaton (NYSE: ETN).

Eaton shares returned 212% over the past decade. How'd they get there?

Dividends were a big help. Without dividends, shares returned 144% over the last 10 years.

Earnings growth was strong over the period. Eaton's normalized earnings per share grew at an average rate of 16.5% from 2001 until today. That's well ahead of the broader market average, and faster than other large industrial companies like General Electric (NYSE: GE) or United Technologies (NYSE: UTX).

And have a look at Eaton's valuation multiple:

Source: S&P Capital IQ.

Eaton's P/E ratio has dropped by about half over the last decade. Put simply, the market doesn't value $1 of Eaton's earnings today as much as it did in the past. That's prevented a lot of its earnings growth over the last 10 years from turning into shareholder returns.

The good news is that, at a reasonable 15 times earnings today, that same phenomenon of collapsing valuation multiples is unlikely to persist over the coming decade, and so more of Eaton's earnings growth should translate into shareholder returns going forward.

This stuff might seem basic, but it's 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.