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, Teva Pharmaceutical
Teva shares returned 220% over the past decade. How'd they get there?
Dividends made up only a small portion. Without dividends, shares returned 194% over the last 10 years.
Earnings growth was substantial. Teva's normalized earnings per share grew at an average rate of 22% a year from 2001 until today -- easily among the upper echelon of large-cap companies over the last decade.
But think about that for a moment. Teva's earnings grew far faster than its shareholder returns. Earnings increased over sixfold, while shares a little more than doubled.
Why? This chart explains it:
Source: S&P Capital IQ.
Like so many large-cap companies -- particularly pharmaceuticals -- Teva was vastly overvalued a decade ago. Valuations have since contracted, preventing a lot of the company's earnings growth from turning into shareholder returns. The same has been true for larger rivals Pfizer
The good news is that, at 15 times earnings, Teva shares now look reasonably valued. The past decade saw shareholder returns stifled due to falling multiples. The coming decade could see rising, even expanding multiples, allowing more of the company's earnings growth to turn into shareholder 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 Teva Pharmaceuticals to My Watchlist.