The Stock Market’s Highest Returns Since 2005
Dear investors,
Despite major short-term challenges, the Brazilian stock market is going through a magnificent period of returns. Since the beginning of 2016, after falling to as low as 38,000 points, the Ibovespa has consistently delivered good results (26% p.a. from 01/17/2016 to 03/01/2021, the closing date of this letter); not even the pandemic, when the index went from 118,000 to 67,000 and back to 118,000 points in less than a year, was able to halt this trend, which has lasted more than five years.
Which factors contributed most to this return? In light of this question, we decided to measure the highest returns on the Brazilian stock market since 2005 and to investigate which companies provided the best returns to investors. For this analysis, we used the concept of Total Shareholder Return (TSR).
TSR breaks down the appreciation of an asset into four components:
- Distribution of dividends;
- Net income growth;
- Expansion of the P/E multiple (Price / Earnings); and
- Combined effect of items 1, 2 and 3.
In short:
TSR = dividends + net income growth + P/E expansion + combined effect
While items 1 and 2 are linked to the company’s performance, item 3 represents a change in investors’ expectations of earnings growth.
To illustrate the growth expectation implied in the expansion of the P/E multiple, suppose that an investor buys a stock at a P/E of 50x. Let us also assume that the company goes through a period of high growth for 10 years, during which it pays out only the mandatory minimum of 25% of net income as dividends and, after this period of strong growth, its net income stabilizes and it begins to distribute 100% of its earnings. For the investor to obtain a real return (above inflation) of 10% per year in the long run, the company’s earnings would have to grow 28% per year above inflation for 10 years! In other words, increase by more than 1,000% over the period. If net income does not grow, the fair multiple to achieve the same rate of return would be 10x P/E. That is, the higher the P/E, the higher the expectation of growth in the company’s net income over the coming years. After all, we imagine that no one would buy an asset expecting to wait 50 years to get the investment back.
The table below shows the best-performing companies since 2005:
Table 1 – Highest annual returns on the Brazilian stock market since 20051
| Company | Annualized return | Dividends | Net income growth | Multiple expansion | Combined effect |
|---|---|---|---|---|---|
| 1 Whirlpool | 31% | 12% | 16% | 1% | 2% |
| 2 Locates | 25% | 2% | 16% | 6% | 1% |
| 3 Comgás | 25% | 10% | 8% | 5% | 2% |
| 4 Espadrilles | 24% | 3% | (1%) | 20% | 1% |
| 5 Renner | 22% | 2% | 17% | 2% | 1% |
| 6 Grazziotin | 22% | 5% | 18% | (2%) | 0% |
| 7 Ferbasa | 20% | 6% | (2%) | 16% | 0% |
| 8 Sanepar | 20% | 7% | 10% | 2% | 1% |
| 9 Coelce | 17% | 8% | 2% | 6% | 1% |
| 10 Safe Harbor | 17% | 5% | 11% | 0% | 1% |
| 11 Sabesp | 16% | 3% | 2% | 10% | 1% |
| 12 Romi | 15% | 5% | 6% | 3% | 1% |
| 13 Engie | 15% | 6% | 8% | 1% | 1% |
| 14 CSN | 15% | 5% | 5% | 4% | 1% |
| 15 Bradespar | 14% | 4% | 1% | 8% | 1% |
Source: Economática, Capital IQ, Ártica analysis
As we can see, Whirlpool (WHRL4) is the company with the highest annualized return over the period, delivering a return of 31% p.a. since 2005. This return was made up of 12% p.a. in dividends, 16% p.a. in net income growth, 1% p.a. in multiple expansion and 2% p.a. from the combined effect. It was a consistent, high-quality return. Whirlpool is a company we know well, as it has been in our portfolio since 2013.
Another point worth highlighting is that most of the returns were driven mainly by net income growth and dividends, and the longer the analysis window, the more this tends to hold true. The chart below shows the return composition of the 15 companies listed in the table above:
1 For the analysis, companies with negative net income in 2005 or 2020 LTM were excluded, since it is not possible to measure their TSR components. In addition, a liquidity filter of >R$25 thousand/day was applied throughout all years of the analysis. The analysis covers the period from 12/29/2005 to 02/26/2021; therefore, companies that went public after the start of this period are not included in the analysis. Some of the companies presented may have been affected by non-recurring items that inflate or reduce net income in the years analyzed. Such effects were not considered in the table.
Chart 1 – Return composition2
Source: Economática, Capital IQ, Ártica analysis
If we now look at returns since 2018, the results show a different dynamic:
Table 2 – Highest annual returns on the Brazilian stock market since 20183
| Company | Annualized return | Dividends | Net income growth | Multiple expansion | Combined effect |
|---|---|---|---|---|---|
| 1 Petro Rio | 167% | 0% | 48% | 81% | 39% |
| 2 Banco Inter | 162% | 1% | (62%) | 591% | (368%) |
| 3 Banco Pan | 153% | 2% | 57% | 58% | 36% |
| 4 Inepar | 111% | 0% | 3% | 105% | 3% |
| 5 Romi | 110% | 15% | 40% | 31% | 24% |
| 6 WEG | 101% | 1% | 29% | 54% | 17% |
| 7 Magazine Luiza | 96% | 0% | (25%) | 161% | (40%) |
| 8 Eneva | 94% | 0% | (11%) | 119% | (13%) |
| 9 CSN | 89% | 3% | (13%) | 110% | (11%) |
| 10 JHSF | 81% | 4% | 61% | 9% | 8% |
| 11 TOTVS | 79% | 1% | 95% | (9%) | (8%) |
| 12 Sinqia | 78% | 0% | (28%) | 147% | (41%) |
| 13 EMAE | 74% | 7% | 5% | 56% | 7% |
| 14 Comgás | 73% | 14% | (7%) | 64% | 3% |
| 15 Kepler Weber | 70% | 1% | 164% | (37%) | (59%) |
Source: Economática, Capital IQ, Ártica analysis
Return composition of a theoretical portfolio made up of the 15 assets in Table 1 above, assuming equal weights for each asset.
For the analysis, companies with negative net income in 2018 or 2020 LTM were excluded, since it is not possible to measure their TSR components. In addition, a liquidity filter of >R$25 thousand/day was applied throughout all years of the analysis. The analysis covers the period from 12/28/2018 to 02/26/2021; therefore, companies that went public after the start of this period are not included in the analysis. Some of the companies presented may have been affected by non-recurring items that inflate or reduce net income in the years analyzed. Such effects were not considered in the table.
For the companies with the highest returns in recent years, the expansion of the P/E multiple was the factor that contributed most to the annualized return, with some interesting cases, such as Banco Inter, where net income declined, but the multiple expansion effect contributed to a return of 591% p.a.! Chart 2 below illustrates the relevance of the multiple expansion effect in the returns of these companies.
Chart 2 – Return composition4
Source: Economática, Capital IQ, Ártica analysis
It is important to note that multiple expansion does not necessarily indicate that the company has become expensive. Other reasons may explain the expansion of this factor: (i) there is an expectation of earnings growth or (ii) the company was cheap and went through a repricing.
Although 2020 was not a “typical” year because of the pandemic, the results obtained are similar to those mentioned by great investors in other periods of history:
“[…] in the short run, the market is like a voting machine – tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company” – Ben Graham
The quote above from Benjamin Graham, considered the father of value investing and Warren Buffett’s mentor, makes this concept explicit. In the short term, stock market fluctuations may be caused by psychological and emotional factors, which lead “Mr. Market” to make stocks very expensive or very cheap; in the long term, the company’s fundamentals eventually prevail and are reflected in its share price.
Return composition of a theoretical portfolio made up of the 15 assets in Table 2 above, assuming equal weights for each asset. It should be noted that, in the analysis, the combined effect is negative, despite the growth in net income and the multiple expansion, because of a strong presence of extreme results, which distorts the consolidated view of the portfolio. Even so, it is possible to see the relevance of multiple expansion as the main contributor to the total return.
In addition to him, John Maynard Keynes, in his work “The General Theory of Employment, Interest and Money”, compared the speculative activity of short-term investors to a beauty contest, in which what matters is not judging who is the most beautiful, but rather judging by imagining whom the others will vote for:
“[…] professionals trade stock, not based on their own long-term forecast of companies’ assets but on the anticipation of market valuation after a few months a company.” – John Maynard Keynes
Keynes, setting aside the merits of the monetary policies he advocated, was an above-average manager, having delivered 16% p.a. in performance between 1922 and 1946, not a bad result considering that it was a very turbulent period for the stock market, with the 1929 crash and World War II between 1939 and 1945.
