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The simplest way to invest in stocks is to buy exchange traded funds. But the truth is, you can make significant gains if you buy good quality businesses at the right price. For example, the Incitec Pivot Limited (ASX:IPL) share price is 17% higher than it was five years ago, which is more than the market average. Zooming in, the stock is actually down 2.9% in the last year.
In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. One flawed but reasonable way to assess how sentiment around a company has changed is to compare the earnings per share (EPS) with the share price.
Incitec Pivot's earnings per share are down 8.4% per year, despite strong share price performance over five years. The strong decline in earnings per share suggests the market isn't using EPS to judge the company. The falling EPS doesn't correlate with the climbing share price, so it's worth taking a look at other metrics.
The revenue growth of 2.1% per year hardly seems impressive. So it seems one might have to take closer look at earnings and revenue trends to see how they might influence the share price.
The chart below shows how revenue and earnings have changed with time, (if you click on the chart you can see the actual values).
Incitec Pivot is a well known stock, with plenty of analyst coverage, suggesting some visibility into future growth. So it makes a lot of sense to check out what analysts think Incitec Pivot will earn in the future (free analyst consensus estimates)
What About Dividends?
As well as measuring the share price return, investors should also consider the total shareholder return (TSR). Whereas the share price return only reflects the change in the share price, the TSR includes the value of dividends (assuming they were reinvested) and the benefit of any discounted capital raising or spin-off. Arguably, the TSR gives a more comprehensive picture of the return generated by a stock. We note that for Incitec Pivot the TSR over the last 5 years was 35%, which is better than the share price return mentioned above. And there's no prize for guessing that the dividend payments largely explain the divergence!
A Different Perspective
While the broader market gained around 12% in the last year, Incitec Pivot shareholders lost 0.9% (even including dividends). Even the share prices of good stocks drop sometimes, but we want to see improvements in the fundamental metrics of a business, before getting too interested. Longer term investors wouldn't be so upset, since they would have made 6.2%, each year, over five years. It could be that the recent sell-off is an opportunity, so it may be worth checking the fundamental data for signs of a long term growth trend. Most investors take the time to check the data on insider transactions. You can click here to see if insiders have been buying or selling.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies we expect will grow earnings.
Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on AU exchanges.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.