Recent 3.4% pullback isn't enough to hurt long-term Cochlear (ASX:COH) shareholders, they're still up 45% over 5 years

Generally speaking the aim of active stock picking is to find companies that provide returns that are superior to the market average. Buying under-rated businesses is one path to excess returns. For example, long term Cochlear Limited (ASX:COH) shareholders have enjoyed a 35% share price rise over the last half decade, well in excess of the market return of around 25% (not including dividends).

While the stock has fallen 3.4% this week, it's worth focusing on the longer term and seeing if the stocks historical returns have been driven by the underlying fundamentals.

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While markets are a powerful pricing mechanism, share prices reflect investor sentiment, not just underlying business performance. One way to examine how market sentiment has changed over time is to look at the interaction between a company's share price and its earnings per share (EPS).

During the five years of share price growth, Cochlear moved from a loss to profitability. That's generally thought to be a genuine positive, so investors may expect to see an increasing share price. Given that the company made a profit three years ago, but not five years ago, it is worth looking at the share price returns over the last three years, too. Indeed, the Cochlear share price has gained 29% in three years. In the same period, EPS is up 11% per year. That makes the EPS growth rather close to the annualized share price gain of 9% over the same period. That suggests that the market sentiment around the company hasn't changed much over that time. There's a strong correlation between the share price and EPS.

You can see how EPS has changed over time in the image below (click on the chart to see the exact values).

We consider it positive that insiders have made significant purchases in the last year. Even so, future earnings will be far more important to whether current shareholders make money. It might be well worthwhile taking a look at our free report on Cochlear's earnings, revenue and cash flow.

What About Dividends?

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 Cochlear the TSR over the last 5 years was 45%, which is better than the share price return mentioned above. This is largely a result of its dividend payments!

A Different Perspective

Investors in Cochlear had a tough year, with a total loss of 9.2% (including dividends), against a market gain of about 6.1%. Even the share prices of good stocks drop sometimes, but we want to see improvements in the fundamental metrics of a business, before getting too interested. On the bright side, long term shareholders have made money, with a gain of 8% per year over half a decade. If the fundamental data continues to indicate long term sustainable growth, the current sell-off could be an opportunity worth considering. It is all well and good that insiders have been buying shares, but we suggest you check here to see what price insiders were buying at.

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of undervalued small cap companies that insiders are buying.

Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on Australian exchanges.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.