5 Important Criteria for Choosing Growth Stocks Based on EPS Ratio

Understand EPS - The Foundation of Smart Investment Decisions

Earnings Per Share (EPS) is one of the most basic indicators helping investors assess the profitability of each stock. Essentially, it is the net profit a company earns per issued share.

The EPS formula is calculated as follows: EPS = (Net Income - Preferred Dividends) / Total Outstanding Shares

In which, net profit after tax = Total revenue - Operating expenses - Corporate income tax

When EPS increases, it usually reflects that the business is operating efficiently, and its profit-generating ability is improving. However, this conclusion can only be made when considering a long-term period (over 5 years).

Specific Illustration: How EPS Affects Stock Price

To better understand the power of EPS, consider a real case:

In 2020, Company X had a net profit of $1,000 with 1,000 shares outstanding in the market. At that time, EPS = 1,000 ÷ 1,000 = $1/share.

In 2021, net profit increased to $1,500, with the same 1,000 shares outstanding. The EPS then was: 1,500 ÷ 1,000 = $1.5/share.

This figure shows EPS increased by 50% in one year. This suggests that the business is developing better and generating more profit. In the long run, the market generally expects the stock price to rise accordingly.

However, in the short term (less than 1 year), an increase in EPS does not always lead to a rise in stock price. The reason is that the stock market is heavily influenced by investor sentiment and overall capital flows.

5 Factors to Combine for Selecting Good Stocks

To improve your investment success rate, you should not rely solely on EPS. Combine the following criteria:

( 1. Revenue must grow steadily

EPS increase is meaningful only when the company’s revenue also grows consistently. When revenue is high, costs are well-controlled, and net profit is higher, EPS will also increase.

Simple rule: Revenue growth → Net profit growth → EPS growth → Potential stock price increase

Note: Some companies may have large assets )land, factories### but weak operating revenue. These assets can generate one-time income but do not reflect the company’s long-term profitability.

( 2. Dividends should be stable and trending upward

Dividends are the portion of profits distributed to shareholders. This is an important signal of the company’s financial health. When a company has good and stable profits, it often tends to increase dividends annually.

McDonald’s is a typical example: total revenue and dividends have increased continuously over 43 years, and the number of new shareholders has also grown each year. This indicates investor confidence in the company’s sustainable profitability.

) 3. The P/E ratio should be reasonable

The Price-to-Earnings (P/E) ratio is the ratio of the current stock price to earnings per share (EPS).

Formula: P/E = Stock Price ÷ EPS

This ratio indicates how much you need to pay to buy one unit of the company’s profit. If P/E is high ###> 25###, the stock price is overvalued; if P/E is low (< 12), the price may be undervalued relative to its potential.

For investors, P/E is like a “time measure” — it helps estimate the initial payback period.

Note: Each industry has its own characteristics, so P/E should be compared within the same industry for accurate assessment.

( 4. The company should have a share buyback policy

When a company repurchases its outstanding shares, the number of shares decreases. This increases EPS without requiring absolute profit growth.

Illustrative example: In 2018, Company AAA had a net profit of $40 and 40 shares outstanding. Then, EPS = 40 ÷ 40 = $1, and the stock price was about $40/share.
In 2019-2020, revenue remained unchanged, but AAA decided to buy back 20 shares. Then: EPS = 40 ÷ 20 = $2

With the same profit level, EPS doubles, and the stock price could rise to $80/share. This is how a company creates value for current shareholders.

Important Warning When Using EPS

) Do not evaluate EPS over too short a period

EPS only reflects the financial status and profitability over a specific period. An increase in EPS over 1-2 years is not necessarily a good signal.

Reason: some companies may generate profits by selling assets like land, buildings, factories — activities unrelated to core business. Looking only at EPS, you might see an increase, but it is not a good long-term investment indicator.

( EPS increase does not mean cash flow is rising

One of the biggest traps is confusing accounting profit with actual cash flow. Netflix )NFLX( is a typical example: its EPS has increased continuously over many years, but operating cash flow is negative, and debt levels are rising.

This means that although the paper profit is high, the company lacks cash to operate. Capital is gradually depleting, which is very dangerous for investors.

Conclusion: Always check the cash flow )Cash flow### report along with EPS to get a comprehensive view of the company’s financial health.