A Brief History of WellPoint's Returns

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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, WellPoint (NYS: WLP) .

WellPoint shares returned 180% over the last decade. How'd they get there?

Dividends helped only marginally. Without dividends, shares returned 177% over the past 10 years.

Earnings growth was surprisingly strong. WellPoint's normalized earnings per share grew by an average of 16.9% a year from 2001 until today. Most health insurers have enjoyed a booming decade -- competitors UnitedHealth Group (NYS: UNH) and Humana (NYS: HUM) both grew earnings by double-digit rates as well.

And have a look at WellPoint's valuation multiple:

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Source: S&P Capital IQ.

Like so many large-cap companies, WellPoint was overvalued a decade ago. Falling valuations ever since have kept shareholder returns lower than they otherwise would be, preventing part of the company's earnings growth from turning into shareholder returns. Put simply, the market doesn't value $1 of WellPoint's earnings as much today as it did in the past. Indeed, WellPoint was an example of a company I once pointed out that doubled earnings while shares went nowhere.

At 10 times earnings, that could change going forward. Shares could easily be considered cheap at current prices. The past decade has been the story of growing earnings and falling valuations. The coming decade could still see strong earnings growth, but stable or even rising valuations, letting far more of WellPoint's internal performance translate 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.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by@TMFHousel. The Motley Fool owns shares of UnitedHealth Group. Motley Fool newsletter services have recommended buying shares of WellPoint and UnitedHealth Group and creating a diagonal call position in UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

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