Practical Guide: How to Use Earning Per Share to Find Potential Stocks

What is Earning Per Share and Why Do Investors Need to Pay Attention?

Earning Per Share (abbreviated as EPS) is a fundamental financial indicator that helps you assess the profitability of each share. Simply put, it is the net profit that each share can generate.

The formula to calculate EPS is quite simple:

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

Where, net profit after tax = Total Revenue - Total Expenses - Corporate Income Tax

This indicator shows the operational performance of a company. When EPS increases, it means the business is creating more value for each shareholder.

From Theory to Practice: A Specific Example of Earning Per Share

Imagine you are tracking Company A for two consecutive years:

2020: Net profit of $1,000 with 1,000 shares issued → EPS = $1/share

2021: Profit increases to $1,500, with no change in the number of shares → EPS = $1.5/share

Thus, the EPS index increased by 50% (from $1 1 to $1.5). This increase reflects that the business is operating more efficiently, with strong profit growth.

However, an important note: An increase in EPS does not automatically lead to an immediate increase in stock price. This depends on short-term market sentiment (less than 1 year). When the market is optimistic, capital flows into risky assets, pushing stock prices up. Conversely, when sentiment is pessimistic, prices will decline.

What factors influence stock prices?

To make sound investment decisions, you should not rely solely on Earning Per Share. Combining other indicators will help you increase your profit-making potential.

5 Criteria for Choosing Good Stocks Based on Earning Per Share

1. Earning Per Share shows an upward trend

This is the most basic criterion. Stocks with continuously increasing EPS indicate that the company is on a growth path.

2. Stable Business Operations

You need to observe the company’s quarterly and annual revenue. If revenue is high and steadily growing, net profit will also increase, leading to higher EPS.

Relationship: Revenue increase → Net profit increase → EPS increase → Stock price increase

A company that only profits from selling land (and factories) without core business revenue is not suitable for long-term investment.

3. Stable and Increasing Dividend Policy

Dividends are the portion of profits distributed to shareholders. The market often looks at dividend policies to assess a company’s financial health. A well-performing company usually pays dividends regularly.

McDonald’s is a typical example: revenue, dividends, and the number of shareholders have all increased steadily over 43 years.

4. Low P/E Ratio (Price-to-Earnings)

The P/E ratio is calculated as: Stock Price ÷ Earning Per Share (EPS)

A high P/E (>25) indicates the stock is overvalued, while a low P/E (<12) suggests a buying opportunity at a reasonable price.

This ratio acts like a “time gauge” – it shows how long it takes to recoup your investment.

Note: Different industries have different normal P/E levels; compare within the same sector.

5. Company Buyback Policy

Share buyback is when a company repurchases its outstanding shares from the market. The goal? Reduce the total number of shares, thereby increasing earnings per share.

Real-world example:

In 2018, company AAA had a net profit $40 and 40 shares outstanding:

• EPS = $40 ÷ 40 = $1
• Stock price around $40/share

In early 2019-2020, the company decided to buy back 20 shares, leaving 20 shares, with profits still at $40:

• New EPS = $40 ÷ 20 = $2
• Stock price could rise to $80/share (doubling)

Companies that perform share buybacks usually have higher stock prices compared to those that do not.

Warnings When Evaluating Earning Per Share

Avoid evaluating EPS based on only 1-2 years

EPS only reflects the current financial situation but does not reveal how the company makes money. For example, a company selling off land (and factories) due to losses in core business may still show increasing EPS, but clearly, it is not a good long-term investment.

EPS can increase while cash flow is negative

Growing EPS does not necessarily mean the business is truly profitable. Netflix is an example: EPS increases continuously, but cash flow is negative, debt is rising, and capital is gradually depleting.

Conclusion: When analyzing Earning Per Share, always combine it with other indicators such as cash flow, revenue, and debt to get a comprehensive view.