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, Best Buy
Best Buy shares returned negative 6% over the last decade. How'd they get there?
Dividends softened the blow. Without dividends, shares lost 15% over the last 10 years.
Earnings growth, however, was remarkably strong. Best Buy's normalized earnings per share grew by an average of 15.1% per year from 2001 until today. That's over double the market average, and far faster than Wal-Mart
But if Best Buy's earnings were so strong, why were its returns so poor? This chart explains it:
Source: S&P Capital IQ.
Like so many other companies, Best Buy was grossly overvalued a decade ago, trading near 40 times earnings. Expectations at those levels could never be met, and so the company's shares have spent the better part of the last decade watching valuations decline to more reasonable levels. That's prevented all of its earnings growth from turning into shareholder returns.
Going forward, it should be a different story. At around eight times earnings, shares indeed look cheap. Best Buy has well-known challenges ahead of it -- not least of which is encroaching competition from Amazon.com
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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