If you want to compound wealth in the stock market, you can do so by buying an index fund. But the truth is, you can make significant gains if you buy good quality businesses at the right price. For example, the Australian Foundation Investment Company Limited (ASX:AFI) share price is up 11% in the last five years, slightly above the market return. In comparison, the share price is down 7.1% in a year.

With that in mind, it's worth seeing if the company's underlying fundamentals have been the driver of long term performance, or if there are some discrepancies.

Check out our latest analysis for Australian Foundation Investment

While the efficient markets hypothesis continues to be taught by some, it has been proven that markets are over-reactive dynamic systems, and investors are not always rational. 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).

Over half a decade, Australian Foundation Investment managed to grow its earnings per share at 1.1% a year. This EPS growth is slower than the share price growth of 2% per year, over the same period. So it's fair to assume the market has a higher opinion of the business than it did five years ago. That's not necessarily surprising considering the five-year track record of earnings growth.

The graphic below depicts how EPS has changed over time (unveil the exact values by clicking on the image). earnings-per-share-growth

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. Dive deeper into the earnings by checking this interactive graph of Australian Foundation Investment'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 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. We note that for Australian Foundation Investment the TSR over the last 5 years was 33%, which is better than the share price return mentioned above. And there's no prize for guessing that the dividend payments largely explain the divergence!



A Different Perspective

Investors in Australian Foundation Investment had a tough year, with a total loss of 3.9% (including dividends), against a market gain of about 4.7%. However, keep in mind that even the best stocks will sometimes underperform the market over a twelve month period. On the bright side, long term shareholders have made money, with a gain of 6% per year over half a decade. 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. I find it very interesting to look at share price over the long term as a proxy for business performance. But to truly gain insight, we need to consider other information, too. Consider risks, for instance. Every company has them, and we've spotted  2 warning signs for Australian Foundation Investment  you should know about.

If you like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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.