EPS Complete Guide: From Understanding to Stock Selection, Essential Profitability Indicator for Investors

What Exactly Is Earnings Per Share (EPS) Measuring?

Earnings Per Share (EPS) is one of the most direct indicators of a company’s profitability. Simply put, it reflects: for every dollar you invest, how much profit does the company generate for you.

The core definition of EPS is Net Income divided by the number of outstanding common shares. The higher this number, the more profit the company has generated with the same amount of equity. From an investment perspective, companies with high EPS typically can produce more returns with fewer shares, making them more attractive and often commanding higher stock prices.

Many professional investors habitually compare a target company’s EPS with that of competitors to assess which company truly has investment value.

How Is EPS Calculated? Practical Case Analysis

Standard Calculation Formula

EPS = (Net Income - Preferred Dividends) / Number of Outstanding Common Shares

The three key elements represent:

• Net Income: The company’s revenue minus all expenses, usually shown at the bottom of the income statement
• Preferred Dividends: Fixed dividends paid to preferred shareholders
• Outstanding Common Shares: Issued shares minus treasury shares

Real-World Example: Using the 2022 Financial Report of Bank of America

Bank of America (BAC.US) clearly shows the calculation process:

Step 1: Obtain net income of $27.528 billion and preferred dividends of $1.513 billion from the income statement.

Step 2: Get the weighted average number of common shares outstanding: 8,113.7 million shares.

Step 3: Plug into the formula: $27.528 billion - $1.513 billion = $26.015 billion
$26.015 billion ÷ 8,113.7 million shares = $3.21

In reality, most financial reports already provide EPS figures directly, so investors don’t need to calculate manually.

How to Check EPS: Two Methods

Method 1: Directly Review Financial Reports (Most Accurate)

• Visit the U.S. Securities and Exchange Commission (SEC) website sec.gov
• Search for the target company’s 10-K annual report or 10-Q quarterly report
• Find “Earnings per Share” in the “CONSOLIDATED STATEMENTS OF OPERATIONS”

Method 2: Use Financial Platforms (Faster)

• Free platforms like SeekingAlpha, Yahoo Finance, etc.
• Be aware of different EPS types: Basic EPS, Diluted EPS, Forecasted EPS
• Generally, retail investors look at basic EPS

Using EPS for Stock Selection: Methods and Limitations

1. Tracking Long-Term EPS Trends

Single-quarter or annual EPS data has limited significance; the key is to observe the growth trajectory over multiple years.

For example, Apple (AAPL.US) from December 2019 to December 2024 shows a steady increase in EPS as the company’s value continues to grow. This consistent upward trend indicates:

• Strengthening profitability
• Optimization of business models
• Greater potential for future returns

Conversely, companies with declining or erratic EPS should be approached with caution.

2. Industry Peer Comparison

Besides vertical comparison over time, horizontal comparison across industry peers is essential. A typical case in the semiconductor industry:

Post-2020, Qualcomm (QCOM.US) has EPS far exceeding NVIDIA (NVDA.US) and AMD (AMD.US). Based on EPS alone, Qualcomm might seem the most promising investment. However, actual stock returns tell a different story:

• NVIDIA 3-year return: 251%
• Qualcomm 3-year return: 69%
• AMD’s performance in the same period is moderate

This illustrates that relying solely on EPS for stock selection can be misleading.

3. Incorporating Price-to-Earnings Ratio (P/E) for More Accurate Judgment

Since companies can reduce circulating shares through buybacks, artificially boosting EPS without actual profit growth, direct comparison of EPS can be misleading.

A more scientific approach is to incorporate P/E Ratio: P/E Ratio = Stock Price ÷ EPS

For example, if Company A’s stock price is $30 and EPS is $1, then P/E is 30. If the industry average P/E is 10, this suggests:

• The stock may be overvalued relative to its earnings
• The market has high growth expectations for Company A

Using P/E ratios for comparison provides a more objective assessment of a stock’s relative value.

Hidden Traps Behind EPS: Important Details You Must Know

How Stock Buybacks Distort EPS

A company can artificially inflate EPS not by increasing profits but by repurchasing its own shares to reduce the number of outstanding shares. If investors focus only on EPS growth without considering changes in share count, they may be misled into thinking profitability is improving.

Impact of Special Items

One-time items such as asset sales, tax rebates, or other extraordinary gains can temporarily boost net income and thus EPS. For example, a restaurant chain selling property might record a large gain, increasing profit temporarily, but this is not reflective of core operations and lacks sustainability.

Investors should focus on Adjusted EPS or Continuing Operations EPS, excluding these irregular items, to see the company’s true operational performance.

How to Identify Special Items

Typically, companies clearly disclose in their financial reports which items are extraordinary and their impact, aiding investors in making adjustments.

Diluted EPS: Why Should You Pay Attention?

What Is Diluted EPS

Financial reports often present two types of EPS:

• Basic EPS: Based on the current actual shares outstanding
• Diluted EPS: Assumes all convertible securities are converted into common shares

Convertible securities include stock options, restricted stock, warrants, convertible bonds, etc. Once these potential shares are converted, the denominator increases, leading to dilution of EPS.

Diluted EPS Calculation Formula

Diluted EPS = (Net Income - Preferred Dividends) / (Outstanding Shares + Convertible Securities)

For example, Coca-Cola (KO.US) in fiscal year 2022:

• Net income: $9,542 million
• Outstanding shares: 4,328 million
• Convertible securities: 22 million

Diluted EPS = $9542 ÷ ( 4328 + 22) = $2.19

Difference Between Basic and Diluted EPS

While diluted EPS appears more conservative, it provides more valuable insight for investors, as it reflects the worst-case scenario for shareholder equity.

The Relationship Between EPS, Stock Price, and Dividends

The Bidirectional Cycle of EPS and Stock Price

Generally, strong EPS drives stock prices upward:

• High stock prices boost market confidence → increased demand → sales growth → higher EPS
• Strong EPS attracts investors → stock prices continue to rise

However, this positive correlation is not absolute. When market expectations for EPS exceed actual reported figures, stock prices may fall even if EPS is growing. Conversely, if actual EPS surpasses market pessimistic estimates, stock prices can rise despite lower-than-expected EPS.

The Interaction Between EPS and Dividends (DPS)

Dividend Per Share (DPS) is the portion of profit paid out to shareholders. It is calculated as total dividends paid divided by the number of outstanding shares.

EPS and DPS both reflect a company’s future prospects but serve different purposes:

• EPS measures how much profit each share generates
• DPS indicates how much profit is returned to shareholders per share

A high dividend yield suggests the company distributes most of its profits, but it may also imply limited reinvestment for growth. Conversely, growth companies often reinvest profits rather than pay high dividends.

Dividend Yield = DPS ÷ Stock Price, a common indicator for investors that directly shows dividend income relative to stock price.

Common Questions and Answers

Q: What EPS number is considered good?

A: There is no absolute “good” number. Judgments should be based on:

• Long-term trend: Is EPS consistently growing year over year?
• Peer comparison: How does EPS compare to industry peers?
• Underlying quality: Is EPS growth driven by genuine profit increases or by stock buybacks and accounting tricks?

Q: Can EPS be forecasted?

A: Yes. Wall Street analysts project future EPS based on company guidance and industry outlooks. Market expectations for EPS reflect investor sentiment about future performance. When actual EPS exceeds expectations, stock prices usually rise.

Q: Why should I pay attention to both basic EPS and diluted EPS?

A: Basic EPS reflects current conditions, while diluted EPS accounts for potential dilution risks. A large gap between the two indicates significant potential dilution from stock options, convertible bonds, etc. Investors need to understand this risk exposure.

Complete Investment Decision Framework

EPS is a powerful analytical tool but not the sole basis for investment decisions. A comprehensive analysis should include:

1. Multi-angle EPS analysis: Long-term trend + peer comparison + quality assessment (excluding special items)
2. Valuation metrics: P/E ratio, EV/EBITDA, etc.
3. Growth prospects: Industry growth potential, company competitive advantages
4. Risk factors: Dilution risk, buyback ratios, debt levels

Only through multi-dimensional, integrated analysis can investors make more informed and prudent decisions.