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:
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, Emerson Electric (NYS: EMR) .
Emerson shares returned 153% over the past decade. How'd they get there?
Dividends made up a big chunk. Without dividends, shares returned 91% over the past 10 years.
Earnings growth was strong. Emerson's normalized earnings per share grew at an average rate of 8.4% per year from 2001 until today. That's comfortably above the market average, and well above other industrial manufacturers like General Electric (NYS: GE) and Hitachi (NYS: HIT) .
But earnings growth alone doesn't explain why Emerson's returns were so strong. Plenty of companies logged solid earnings growth over the last decade, yet saw shareholder returns languish.
To understand why Emerson didn't end up in that boat, have a look at the company's valuation multiple:
Source: S&P Capital IQ.
Unlike so many other stocks, Emerson wasn't overvalued 10 years ago. That's allowed the earnings growth it has enjoyed over the past 10 years to materialize into shareholder returns, rather than being discounted by the market through falling valuation multiples.
This should home in on one of the most important lessons in investing: starting valuations determine future returns. A mediocre company bought at a good price can generate good returns. A great company bought at a dear price can leave shareholders stranded.
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 Emerson Electric to My Watchlist.
At the time thisarticle was published Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Emerson Electric. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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