These days it's easy to simply buy an index fund, and your returns should (roughly) match the market. But in our experience, buying the right stocks can give your wealth a significant boost. For example, the Xylem Inc. (NYSE:XYL) share price is up 91% in the last five years, slightly above the market return. Zooming in, the stock is actually down 7.9% in the last year.

Since the stock has added US$1.8b to its market cap in the past week alone, let's see if underlying performance has been driving long-term returns.

We check all companies for important risks. See what we found for Xylem in our free report.

While markets are a powerful pricing mechanism, share prices reflect investor sentiment, not just underlying business performance. One flawed but reasonable way to assess how sentiment around a company has changed is to compare the earnings per share (EPS) with the share price.

During five years of share price growth, Xylem achieved compound earnings per share (EPS) growth of 13% per year. This EPS growth is remarkably close to the 14% average annual increase in the share price. Therefore one could conclude that sentiment towards the shares hasn't morphed very much. Indeed, it would appear the share price is reacting to the EPS.

The image below shows how EPS has tracked over time (if you click on the image you can see greater detail).

We know that Xylem has improved its bottom line lately, but is it going to grow revenue? You could check out this free report showing analyst revenue forecasts.

What About Dividends?

When looking at investment returns, it is important to consider the difference between total shareholder return (TSR) and share price return. Whereas the share price return only reflects the change in the share price, the TSR includes the value of dividends (assuming they were reinvested) and the benefit of any discounted capital raising or spin-off. Arguably, the TSR gives a more comprehensive picture of the return generated by a stock. We note that for Xylem the TSR over the last 5 years was 103%, 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

Xylem shareholders are down 6.9% for the year (even including dividends), but the market itself is up 11%. 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 15% 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. If you would like to research Xylem in more detail then you might want to take a look at whether insiders have been buying or selling shares in the company.

We will like Xylem better if we see some big insider buys. While we wait, check out this free list of undervalued stocks (mostly small caps) with considerable, recent, insider buying.

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.