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:
- 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, Waste Management (Nasdaq: WM ) .
Waste Management shares returned 59% over the past decade. How’d they get there?
Dividends accounted for a lot of it. Without dividends, shares gained about 25% over the past 10 years.
Earnings growth was fairly strong. Waste Management’s normalized earnings per share grew at an average rate of 7.2% over the past decade. Given two recessions, that’s not bad. Others like Republic Service (NYSE: RSG ) and Waste Connections (NYSE: WCN ) saw strong earnings growth over decade as well. Trash isn’t a bad industry to be in.
But if Waste Management’s earnings were so strong, why were returns so meager? This chart explains it:
Source: S&P Capital IQ.
Waste Management’s P/E ratio has dropped by about 40% since 2001. That isn’t rare; many large-cap stocks have seen their valuations contract over the past decade as the late ’90s stock bubble deflated. What that’s done is prevented a lot of the company’s earnings growth from showing up in shareholder returns. The market isn’t willing to pay as much for Waste Management’s earnings as it has in the past.
At less than 15 times earnings — 13 times earnings on a forward-looking basis — shares now look reasonably valued, if not cheap. Going forward, that should help more of Waste Management’s earnings growth be reflected in 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.