Generally speaking the aim of active stock picking is to find companies that provide returns that are superior to the market average. And while active stock picking involves risks (and requires diversification) it can also provide excess returns. For example, the Rio Tinto Group (LON:RIO) share price is up 81% in the last 5 years, clearly besting the market decline of around 7.5% (ignoring dividends). On the other hand, the more recent gains haven't been so impressive, with shareholders gaining just 4.4% , including dividends .
While this past week has detracted from the company's five-year return, let's look at the recent trends of the underlying business and see if the gains have been in alignment.
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.
During five years of share price growth, Rio Tinto Group achieved compound earnings per share (EPS) growth of 38% per year. The EPS growth is more impressive than the yearly share price gain of 13% over the same period. So it seems the market isn't so enthusiastic about the stock these days. The reasonably low P/E ratio of 5.21 also suggests market apprehension.
The graphic below depicts how EPS has changed over time (unveil the exact values by clicking on the image).
We know that Rio Tinto Group has improved its bottom line lately, but is it going to grow revenue? This free report showing analyst revenue forecasts should help you figure out if the EPS growth can be sustained.
What About Dividends?
When looking at investment returns, it is important to consider the difference between total shareholder return (TSR) and share price return. The TSR incorporates the value of any spin-offs or discounted capital raisings, along with any dividends, based on the assumption that the dividends are reinvested. So for companies that pay a generous dividend, the TSR is often a lot higher than the share price return. As it happens, Rio Tinto Group's TSR for the last 5 years was 182%, which exceeds the share price return mentioned earlier. The dividends paid by the company have thusly boosted the total shareholder return.
A Different Perspective
It's nice to see that Rio Tinto Group shareholders have received a total shareholder return of 4.4% over the last year. That's including the dividend. Having said that, the five-year TSR of 23% a year, is even better. The pessimistic view would be that be that the stock has its best days behind it, but on the other hand the price might simply be moderating while the business itself continues to execute. While it is well worth considering the different impacts that market conditions can have on the share price, there are other factors that are even more important. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Rio Tinto Group (at least 1 which is concerning) , and understanding them should be part of your investment process.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on GB exchanges.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.