A Brief History of Home Depot's Returns

Despite constant attempts by analysts and the media to complicate the basics of investing, there are really only three ways a stock can create value for its 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, Home Depot (NYS: HD) .

Home Depot shares returned just 10% over the past decade. How'd they get there?

Dividends pulled most of the weight. In fact, without dividends, shares actually generated an 11% loss of the past ten years.

Earnings growth was solid during the period. Home Depot's earnings per share grew at an average rate of 7.3% per year over the past decade. That's a very decent performance, especially given the collapse of the housing industry in recent years. Heck, it would have been a good performance even without the housing crash.

So what happened to shareholder returns? This chart explains it:


Source: S&P Capital IQ.

Home Depot's earnings multiple has dropped by over half during the past decade. In a sense, every bit of earnings growth the company has achieved has been discounted completely by the market. You could have seen this coming; shares were grossly overvalued ten years ago. The same is true for Lowe's (NYS: LOW) and other retailers like Target (NYS: TGT) -- good internal performance has been masked by a compression in earnings multiples. The good news is that shares are much more reasonably valued today, so shareholders aren't likely to suffer the same fate going forward.

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 thisarticle was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.Motley Fool newsletter serviceshave recommended buying shares of Home Depot and Lowe's, as well as writing covered calls in Lowe's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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