One simple way to benefit from the stock market is to buy an index fund. But if you choose individual stocks with prowess, you can make superior returns. For example, Insurance Australia Group Limited (ASX:IAG) shareholders have seen the share price rise 87% over three years, well in excess of the market return (25%, not including dividends). However, more recent returns haven’t been as impressive as that, with the stock returning just 16% in the last year, including dividends.
So let’s investigate and see if the longer term performance of the company has been in line with the underlying business’ progress.
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While the efficient markets hypothesis continues to be taught by some, it has been proven that markets are over-reactive dynamic systems, and investors are not always rational. One imperfect but simple way to consider how the market perception of a company has shifted is to compare the change in the earnings per share (EPS) with the share price movement.
During three years of share price growth, Insurance Australia Group achieved compound earnings per share growth of 60% per year. This EPS growth is higher than the 23% average annual increase in the share price. Therefore, it seems the market has moderated its expectations for growth, somewhat.
The graphic below depicts how EPS has changed over time (unveil the exact values by clicking on the image).
It is of course excellent to see how Insurance Australia Group has grown profits over the years, but the future is more important for shareholders. You can see how its balance sheet has strengthened (or weakened) over time in this free interactive graphic.
As well as measuring the share price return, investors should also consider the total shareholder return (TSR). The TSR is a return calculation that accounts for the value of cash dividends (assuming that any dividend received was reinvested) and the calculated value of any discounted capital raisings and spin-offs. Arguably, the TSR gives a more comprehensive picture of the return generated by a stock. We note that for Insurance Australia Group the TSR over the last 3 years was 107%, 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!
Insurance Australia Group provided a TSR of 16% over the year (including dividends). That’s fairly close to the broader market return. It has to be noted that the recent return falls short of the 17% shareholders have gained each year, over half a decade. More recently, the share price growth has slowed. But it has to be said the overall picture is one of good long term and short term performance. Arguably that makes Insurance Australia Group a stock worth watching. It’s always interesting to track share price performance over the longer term. But to understand Insurance Australia Group better, we need to consider many other factors. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Insurance Australia Group (at least 1 which doesn’t sit too well with us) , and understanding them should be part of your investment process.
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