Signal From Noise: Introducing the Total Shareholder Return Framework

August 24, 2020
By Phil Beckner, CFA®, CAIA® and Ryan Streilein, CFA®

Have you ever wondered why a stock goes up? The easiest and most obvious answer is — there are more buyers than sellers! That’s true, but it doesn’t completely answer the question. In truth, any number of factors are at play in the short run. But, in the long run, stock returns ultimately reflect changes in underlying company fundamentals. At West Financial, we seek to align our investment time horizon with your longer-term goals. Using a Total Shareholder Return (TSR) framework, investors often view longer-term returns as a product of three key fundamental drivers that can be measured and analyzed: earnings growth, multiple expansion, and dividends. Understanding these drivers — and their ability to change — can provide valuable insights into your portfolio. 

Earnings Growth 
Since companies are ultimately valued on their cash flows, growth in earnings is a natural contributor to returns. Earnings growth can be broken into two driving factors: revenue growth and margin expansion. From 2015 through 20201, semiconductor company Nvidia’s earnings-per-share grew 38.9%2 a year, as result of 16.3%2 growth in revenue, and 19.32 percentage point increase in net margin. Thanks in part to that remarkable growth, NVDA shareholders enjoyed a 66.4%3 annualized return over that time.

Investors should consider whether earnings growth is sustainable, particularly for growth significantly above industry averages. Companies selling to expanding markets, or with opportunities for margin improvement, may indeed continue to enjoy robust growth. However, those operating in mature markets, exhibiting higher competition, may be challenged to maintain their historical growth.

Multiple Expansion 
Multiple expansion refers to the increase in value investors ascribe to a company’s earnings. Growth in a commonly used metric such as the price-to-earnings (PE) ratio is often a significant contributor to stock returns. A notable example is Proctor & Gamble, which from 2014 to 20191 saw its PE multiple expand from 18.6x to 24.25x2, contributing 53%4 of the total 10.4%3 annualized shareholder return in that time. A myriad of factors influence multiple expansion, but two notable drivers are interest rates and market sentiment. Low or declining interest rates tend to increase multiples, as does bullish market sentiment. 

It is important for investors to consider whether multiple expansion is justified. Healthy multiple expansion typically corresponds with improvements in other fundamentals, like a strengthened balance sheet or renewed earnings growth or quality. Unhealthy multiple expansion, in contrast, has little to no fundamental basis and is driven more by overly optimistic sentiment.

Dividends are a direct contributor to stock returns — it’s simply the cash portion of that return. Dividends can be a significant return driver for companies that tend to pay out a significant portion of their earnings as dividends, like mature companies or REITs. Take for instance regional utility Dominion Energy, which realized a 5.8%3 return per year from 2014 to 20191. Nearly three-fourths4 of that return came from dividends, averaging a 4.3%2 yield per year. For companies that pay little to no dividends, the contribution from yield is smaller. These often young or fast-growing companies may instead use the cash they generate to pursue other goals, like paying down debt to improve their balance sheets, reinvesting in existing business lines, or acquiring other firms to spur growth. If successful, these improvements should promote the other drivers of returns and compensate for the lack of dividend. 

As with earnings growth, investors should consider the sustainability of dividends. Companies that sport unusually high yields may not be investing enough capital back into the business, putting future dividends in jeopardy. Also, keep in mind share repurchases are another way companies may return capital to shareholders. While the return contribution from buybacks is not as obvious as that from dividend yields (buybacks are ultimately reflected in earnings growth), it can be a significant driver of returns. 

As pundits on CNBC and Bloomberg remind us daily, countless factors roil stock returns in the short run, but for most investor’s longer-term returns are what counts. Keep in mind some of the drivers of those returns  — earnings growth, multiple expansion, and dividend yields — and you can separate the signal from the noise. 

Flowchart illustrating the breakdown of the total returns to shareholder framework.The top left corner displays the company stock symbol, NVDA. Below this shows the fiscal years for which the company data is presented. The from date is fiscal year 2015 and the to date is fiscal year 2020. This represents 5 years of data which is displayed below the to date. To the right of the description information the chart displays the calendar dates used to calculate the stock price return over that time period. The calendar dates are from 01/31/2015 to 01/31/2020. The next box to the right of this shows the header of annualized price return. Below this shows the stock price of $19.21 matching up with the starting calendar date, while the final stock price of $236.43 is for the ending calendar date. The annualized price return of 65.2% is directly below. Two arrows stem from the price return (annualized) box. The left arrow leads to a P/E Multiple (FYE) box. This box notes the fiscal year end P/E (price-to-earnings) multiple starting in 2015 and then displays the final P/E multiple in 2015. Below this is the contribution number of 34.6%. This number indicates that 34.6% of the 65.2% annualized price return, was driven by P/E multiple expansion. The right arrow leads to a box labeled EPS Return (FYE). This box notes the fiscal year end EPS (earnings per share) starting in 2015 and then displays the finishing EPS in 2020. Below this is the contribution number of 65.4%. This number indicates that EPS contributed to 65.4% of the 65.2% annualized price return. This EPS box has two arrows under it as well. The flowchart is showing the drivers that make up the EPS. To the left arrow, Net Margin (FYE) is shown. Right below that header displays the starting net margin in 2015 and under that number displays the ending margin in 2020. The final line of the Net Margin (FYE) box shows that margin expansion contributed to 54.1% of the EPS growth. The arrow to the right has a header of Sales/Share (FYE). Right below that header displays the Sales-per-share in 2015 and under that number displays the sales-per-share in 2020. The final line in that box indicates that sales-per-share growth contributed to 45.9% of the EPS growth. Under the flowchart, there are two tables. The first table displays the how each factor (from left to right: PE Multiple Expansion, Sales Per Share Growth, Profit Margin Expansion) contributes to the annual price return. The second table displays how each factor (from left to right: PE Multiple Expansion, Sales Per Share Growth, Profit Margin Expansion, Dividend) contributes to the stocks total return. Table 1: The first line under the first table header represents the cumulative improvement in each factor. The second line, indicates the contribution of each factor, and the third line breaks down how much of the annualized return can be attributed to each factor. The final column to the right shows the summation of the price return.Table 2: The first line under the first table header is blank, except for the 4th column under the dividend header. The second line represents contribution of each factor in regards to the total return of the stock. The third line breaks down how much of the annualized total return can be attributed to each factor and is illustrated in the waterfall chart. This table has one difference from the first table and that is the inclusion of dividends. The final column on the right shows the summation of the total return, which is 66.4%.


Meet Phil Beckner, CFA®, CAIA® and Ryan Streilein, CFA® »

Company Fiscal Year
Calculated using FactSet’s Estimates Database
3 Total return calculated with Calendar Year Dates using FactSet’s Price Database
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