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Why Total Return Trumps Growth & Value

 Published 5/28/14

There are two artificial camps in investing: value and growth.

What really matters in investing is total return, but we will get to that a little bit later on.

First things first, are you a growth investor, or a value investor?


Growth Investors

Growth investors look for businesses that are growing quickly; earnings per share is not as important as the long-term prospects and recent growth rate of the business.  Growth investors forecast growth far into the future, judge potential, and invest accordingly.


Value Investors

Value investors do the opposite.  Value investors attempt to find businesses trading at a discount to their intrinsic value.  Intrinsic value is not easy (or even possible) to calculate.  It would be great if every stock had the real intrinsic value listed next to the price.  Unfortunately, this is NOT the case.  Many value investors instead focus on finding businesses that have low valuation ratios:  low P/E, low P/B, low EV/EBIT, etc.


Growth, Value?  I Care About Total Return

Of course, these categories are artificial.  The only thing that matters in investing is total return.  Don’t ask “growth or value?”, instead ask “at what rate will this investment compound, and for how long?”.   Total return is entirely dependent on 3 variables and is expressed in a simple formula below.

Total Return Formula


Intrinsic Value

Change in intrinsic value is another way of saying growth.  There are several measures to approximate change in intrinsic value:  Earnings per share growth, revenue per share growth,  and growth in book value per share are all popular metrics to measure change in intrinsic value.  Notice that per share intrinsic value can be increased by either growing the business or reducing share count.  A business with no revenue growth that buys back 10% of its market cap a year would have intrinsic value per share grow by 10% a year (everything else being equal).

The 8 Rules of Dividend Investing measures change in intrinsic value as the lesser of per share growth in revenue or dividends.   Per share revenue growth tends to accurately reflect true business growth as it is not affected by short-term changes in operating or profit margins.

Revenue per share growth does not accurately reflect business growth if/when a business acquires a low margin business that greatly boosts revenue, but does not significantly boost earnings.  That is why we use dividend per share growth as a catch all.  If revenue per share grows 20% a year, and dividends are only growing 5% a year, this is a solid indication that the business is tacking un unprofitable or very low margin sales to boost size.

An example of a business rapidly boosting revenue per share while minimally impacting real earnings and dividends is Pepsi’s (PEP) acquisition of 2 large bottlers for $7.8 billion in 2009.

It is important to remember that businesses can affect their intrinsic values.  An excellent CEO will increase intrinsic value over time, while a negligent CEO can destroy value quickly.  Businesses with a long history of growth have proven they can grow intrinsic value under different CEOs.

“Go for a business that any idiot can run – because sooner or later any idiot probably is going to be running it.”
– Peter Lynch


Valuation Multiple

Total return is also affected by changes in the valuation multiple.  This could be an increase or decrease in P/E, P/B,  etc.  Businesses have no control over their valuation multiples.  They whims of the stock market control valuation multiples.  Valuation multiples reflect the fickle expectations of the crowd.  It is exciting to see a business you own jump from a P/E of 15 to 30, but this is not something one can expect or control by investing in the right businesses.

When valuation ratios change, real economic growth or decline has not occurred.  If Coca-Cola goes from a P/E of 20 to 40… or 10 for that matter, they are still selling the same amount of Coke’s in the real (non Wall Street) world.

With that said, purchasing stocks with very high P/E ratios is NOT a recipe for success.  From 1951 to 2013, the 10% of stocks with the cheapest P/E ratios outperformed the 10% of stocks with the highest P/E ratios by…  Drumroll please….  An average of 8.4% PER YEAR.

PE Matters Chart

Source:  Greenbackd (data from Fama & French)

The reason that ‘value’ (bottom 10% of P/E ratios) outperforms glamour (top 10% of P/E ratios) is because glamour stocks must work off their excessive valuations.  If a business is growing at 20% a year, but it has a P/E ratio of 50, it will take over 6 years for the business to break even if the P/E ratio falls to 15.  No businesses grow extremely fast forever.  When growth falls from 20% to 8%, the P/E ratio will as well.  Investing in low P/E stocks prevents errors in estimating how long a fast growing company will grow.



The final variable that determines total return is dividends.  Dividend yield is knowable (unlike intrinsic value), and controllable by the business (unlike valuation).  These two factors make dividends the easiest of the 3 total return variables to gauge.

Just because dividend yield is easier to gauge does not mean it is less important.  Dividends have been responsible for 42% of total stock market returns since 1930.


Source:  Business Insider (Morgan Stanley Data)

Keep in mind price appreciation is a mixture of valuation change and change in intrinsic value.  Dividends are more responsible for total return than any other factor.



Successful investing is rationally analyzing businesses based on their total return prospects.  Buying as stock because it’s “growth” or “value” oversimplifies the investing process.  What investing thesis makes more sense to you?

  1. I bought this stock because it has a P/E of 12.  It looks really cheap right not, and I think I could make a quick 50% if the P/E ratio goes to 18.
  2. I bought this stock because I think it will quadruple in size at some point.  It has been growing at 35% a year for the last 2 years.  It is new, but the growth story is potentially huge.
  3. I bought this stock because it has an expected total return of 12% from dividends (3%) and growth (9%).  It has a proven record of success and will likely continue on its current path.  It appears to be fairly valued with a P/E ratio of 17, in line with its historical P/E and its peers.

The first investing thesis appears speculative; one is hoping for price appreciation without a solid reason.  The second thesis also appears to be speculative; with only 2 years of historical data it is very difficult to say how large (or profitable) the company may one day become.

The third thesis takes a balanced long-term approach.  You don’t get as high a chance for a quick doubling in share price from low P/E ratios or high growth.  What you do get is safety from investing in a proven company and reasonable expectations for solid returns over a long-period of time.  I believe thesis 3 to be the most beneficial for investors looking to maximize total return.

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