Investing in Lithia Motors (NYSE:LAD) three years ago would have delivered you a 49% gain

Investors can buy low cost index fund if they want to receive the average market return. But if you invest in individual stocks, some are likely to underperform. That's what has happened with the Lithia Motors, Inc. (NYSE:LAD) share price. It's up 46% over three years, but that is below the market return. Zooming in, the stock is actually down 5.2% in the last year.

Now it's worth having a look at the company's fundamentals too, because that will help us determine if the long term shareholder return has matched the performance of the underlying business.

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In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. 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 three years of share price growth, Lithia Motors actually saw its earnings per share (EPS) drop 6.1% per year.

Thus, it seems unlikely that the market is focussed on EPS growth at the moment. Since the change in EPS doesn't seem to correlate with the change in share price, it's worth taking a look at other metrics.

Languishing at just 0.7%, we doubt the dividend is doing much to prop up the share price. It may well be that Lithia Motors revenue growth rate of 12% over three years has convinced shareholders to believe in a brighter future. In that case, the company may be sacrificing current earnings per share to drive growth, and maybe shareholder's faith in better days ahead will be rewarded.

The company's revenue and earnings (over time) are depicted in the image below (click to see the exact numbers).

Lithia Motors is a well known stock, with plenty of analyst coverage, suggesting some visibility into future growth. Given we have quite a good number of analyst forecasts, it might be well worth checking out this free chart depicting consensus estimates.

What About Dividends?

It is important to consider the total shareholder return, as well as the share price return, for any given stock. The TSR incorporates the value of any spin-offs or discounted capital raisings, along with any dividends, based on the assumption that the dividends are reinvested. Arguably, the TSR gives a more comprehensive picture of the return generated by a stock. As it happens, Lithia Motors' TSR for the last 3 years was 49%, which exceeds the share price return mentioned earlier. And there's no prize for guessing that the dividend payments largely explain the divergence!

A Different Perspective

While the broader market gained around 19% in the last year, Lithia Motors shareholders lost 4.5% (even including dividends). However, keep in mind that even the best stocks will sometimes underperform the market over a twelve month period. Longer term investors wouldn't be so upset, since they would have made 0.8%, each year, over five years. It could be that the recent sell-off is an opportunity, so it may be worth checking the fundamental data for signs of a long term growth trend. While it is well worth considering the different impacts that market conditions can have on the share price, there are other factors that are even more important. For instance, we've identified 1 warning sign for Lithia Motors that you should be aware of.

If you would prefer to check out another company -- one with potentially superior financials -- then do not miss this free list of companies that have proven they can grow earnings.

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