Decomposing TSR  75
EXHIBIT 5.2  TSR Driven by Revenue Growth, Margin, ROIC, and Changes in 
Expectations
Total shareholder 
returns (TSR)
Market value 
increase
Dividends1/ 
market value 
of equity
Net-income 
growth
Change in 
multiple
Earnings yield 
(net income/market 
value of equity)
Investment 
(investment/market 
value of equity)
Revenue 
growth
Margin 
change
Revenue 
growth
Return on invested 
capital (ROIC)
Note: Assumes company has no debt and no share repurchases.
1Dividends = Net Income – Investment
A second problem is that this approach assumes that the dividend yield 
can be increased without affecting future earnings and dividends, as if divi-
dends themselves create value. But dividends are merely a residual. For exam-
ple, if a company pays a higher dividend today by taking on more debt, that 
simply means future dividends must be lower because future interest expense 
and debt repayments will be higher. Similarly, if a company manages to pay a 
higher dividend by forgoing attractive investment opportunities, then future 
dividends will suffer, as future cash flows from operations will be lower.
Finally, the traditional expression of TSR fails to account for the impact of 
financial leverage: two companies that create underlying value equally well 
could generate very different TSR, simply because of the differences in their 
debt-to-equity ratios and the resulting differences in the risk to their investors.
To avoid these problems, we can decompose the traditional TSR compo-
nents into ones that provide better insight into understanding the underlying 
sources of value creation. Exhibit 5.2 shows this graphically.
The derivation works as follows. Assume a company with no debt pays 
out all its cash flow as dividends. Start with the traditional definition:
TSR
Percent Change in Net Income
Percent Change in P/E
Div
=
+
+
idend Yield

76  The Alchemy of Stock Market Performance
The percent increase in earnings can be decomposed into the increase in rev-
enues and the change in profit margin:5
Percent Change in Net Income
Percent Increase in Revenues
=
+ Impact of Increase in Profit 
Margin on Net Income
The dividend yield also can be decomposed:
Dividend Yield
Dividends
Market Value
=
In this simplified example, where the company pays out all its cash flow as 
dividends, dividends will equal net income less investment. Therefore, the 
dividend yield can be expressed as the earnings yield (net income divided 
by market value) less the percent of market value invested back into the 
business:
Dividend Yield
Net Income
Market Value
Investment
Market 
=
−
Value
Putting these components together gives the following expression for TSR:
TSR
Percent Change in Revenue
Investment
Market Value
Impac
=
−
+
t of Change in Profit Margin
Net Income
Market Value
Perce
+
+
nt Change in P/E
To summarize, TSR is driven by these five factors:
1. Revenue growth
2. Investment required to achieve that revenue growth
3. Impact of a change in margin on net income growth
4. Starting ratio of net income to market value (which is the inverse of 
the P/E ratio)
5. Change in P/E ratio
The investment required for growth is a function of growth and ROIC, as 
described in Chapter 3:
Investment
Net Income
Growth ROIC
=
×
/
5 To be precise, there is an additional cross-term that reflects the interaction of these two effects, which 
we have omitted to focus on the key points.

Decomposing TSR  77
The percent of market value invested therefore equals
Investment
Market Value
Net Income
Growth/ROIC
Market Value
=
×
= Net Income
Market Value
Growth
ROIC
×
The ratio of net income to market value is just the inverse of the P/E ratio; 
therefore,
Investment
Market Value
P E
Growth ROIC
=
×
1
/
/
Now we can see how TSR is driven by growth and ROIC, adjusted by the 
beginning P/E.
Exhibit 5.3 uses the financials of hypothetical Company A to compare 
the traditional method of TSR decomposition with our enhanced approach.6 
Looking at the two decomposition approaches on the right side of the exhibit, 
the traditional approach indicates that Company A has a 14.4 percent TSR, 
based on 7 percent earnings growth, a 3 percent change in the company’s 
P/E (a proxy for changed expectations), and a 4.4 percent dividend yield. 
The enhanced approach breaks down the TSR of Company A into three of the 
four parts of our full process of decomposition (for simplicity, in this example, 
Company A does not increase its margins). This shows that not much of the 
14.4 percent TSR reflects the creation of new value. First, the reinvestment 
required to achieve 7 percent growth in earnings consumed most of the earn-
ings growth itself, leaving TSR arising from performance at only 1.4 percent. 
Another 3 percent of TSR comes from a change in shareholder expectations 
(reflected in the P/E multiple increase), rather than performance, and the 
6 The example assumes no changes in profit margins for both companies, so that earnings growth can 
arise only from investments.
EXHIBIT 5.3  Traditional vs. Enhanced TSR Decomposition
Company A financials
Decomposition of TSR
$ million
Base year
1 year later
%
Traditional
Enhanced
Invested capital
100.0
107.0
Growth
7.0
7.0
Earnings
12.5
13.4
Required investment
–
(5.6)
TSR from performance
7.0
1.4
P/E (multiple)
10.0
10.3
Equity value
125.0
137.5
Earnings yield
–
10.0
Dividends
5.0
5.5
Change in P/E
3.0
3.0
Dividend yield
4.4
–
TSR, %
14.4
TSR, %
14.4
14.4