Growth Stock Selection Strategy: Golden Principles When Using the EPS Indicator

Why do investors need to understand what EPS is?

In the stock market, there are many indicators to evaluate a stock’s growth potential. However, if you want to build a sustainable long-term portfolio, mastering what EPS is and how to apply it in your analysis process is a key factor. EPS is not just a number; it is a bridge that helps you understand the actual profitability of each business.

What is EPS (Earnings Per Share)?

What is EPS? This is a metric that measures the net profit a company generates for each outstanding share in the market. The calculation formula for EPS is quite simple:

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

Or it can be rewritten as:

EPS = Net Profit After Tax ÷ Total Outstanding Shares

Where net profit after tax is calculated as: Total Revenue - Total Operating Expenses - Corporate Income Tax

This indicator helps investors quickly assess the company’s business performance. If EPS increases, it usually signals that the business is operating more efficiently.

Practical example of how to calculate EPS

Let’s consider the situation of Company B over two consecutive years:

2020: Net profit is $1,000, and the number of shares outstanding is 1,000 shares

• EPS = $1,000 ÷ 1,000 = $1/share

2021: Net profit increases to $1,500, and the number of shares remains at 1,000

• EPS = $1,500 ÷ 1,000 = $1.5/share

Thus, the EPS has increased by 50% (from $1 1 to $1.5). This reflects that the company is growing, and its profitability has significantly improved. According to market logic, the stock price is generally expected to rise in the long term.

However, it is important to note that an increase in EPS does not always mean that the stock price will rise immediately. The reason is that short-term stock prices (less than 1 year) are heavily influenced by market sentiment, global capital flows, and other macroeconomic factors.

Factors that determine stock price: Market psychology vs. Fundamental data

Stock prices are influenced by two main forces:

When the market is optimistic, capital flows into investment sectors like stocks, real estate, forex… making the market vibrant. Conversely, when the market is pessimistic, investors withdraw from high-risk investments, leading to market decline over 6 months to 1 year.

Five principles for selecting potential stocks using the EPS indicator

Not every EPS increase means a stock is a good investment choice. To improve the chances of profit, you need to combine multiple criteria:

1. The EPS must be high and have an increasing trend

This indicates the company is profitable and expanding that profit over time.

2. Business operations must be stable

Revenue does not necessarily need to grow rapidly, but it should be consistent. The company should not have alternating good and bad years.

3. Dividend rate (Dividend) must be stable or trending upward

When a company pays dividends, it signals that the company has real profits, not just “on paper.” Additionally, investors will receive annual income from dividends.

4. P/E ratio must be reasonable

P/E ratio = Stock Price ÷ EPS. This indicates how many years it would take for an investor to recover their investment.

• P/E < 12: Stock is undervalued (buying opportunity)
• P/E > 25: Stock is overvalued (be cautious)

However, each industry has its own characteristics, so P/E should be compared with the industry average.

5. The company should have a share buyback policy

What is share buyback? It is when a company spends money to repurchase its own outstanding shares, thereby reducing the number of shares in circulation.

Benefits: When the number of shares decreases but net profit remains (or increases), EPS will rise, increasing value for remaining shareholders.

Example: Company C in 2018 has a net profit of $40 million, with 40 million shares outstanding. EPS = $1, stock price around $40.

In 2019-2020, net profit remains $40 million, but the company repurchases 20 million shares. Now, EPS = $40 million ÷ 20 million = $2. Stock price could potentially double $80 (.

The relationship between EPS and revenue: Growth chain

To understand a company’s profitability, what is EPS is just the first step. You need to monitor revenue )Revenue( each period.

Generally, larger revenue leads to higher net profit, which increases EPS, and consequently, the stock price.

Growth chain: Revenue ↑ → Net Profit After Tax ↑ → EPS ↑ → Stock Price ↑

However, it is crucial to distinguish whether the company earns profits from actual business operations or from selling assets )land, factories, offices(. In the latter case, even if EPS increases, the stock may not be worth investing in because the company is in decline.

The relationship between EPS, dividends, and the company’s financial health

Dividends are the portion of profits distributed to shareholders. The market often uses dividends as a “measure” of a company’s financial health:

• If the company performs well: It will pay dividends to shareholders
• If the company faces difficulties: Dividends will decrease or be cut

Companies that maintain or increase dividends over many years are usually financially solid and well-managed. This builds investor confidence for the long term.

P/E ratio: A tool to measure the true value of a stock

P/E = Stock Price ÷ EPS )Earnings Per Share(

This ratio indicates how many units of currency you need to pay to earn )the company’s profit$1 .

• High P/E (> 25): Stock is overvalued; investors expect very strong growth in the future
• Low P/E (< 12): Stock is undervalued; it may be a buying opportunity or the company is facing issues

However, different industries have different standards, so “high” and “low” P/E vary. For example, the tech sector often has higher P/E ratios than traditional energy industries.

Share buyback strategy: How to optimize EPS

Share buyback is a tool used by companies to increase stock value without necessarily increasing profits significantly. By reducing the number of shares outstanding, EPS will automatically increase (assuming net profit remains unchanged).

This benefits current shareholders because:

• Their shares become more valuable
• They have opportunities to realize gains or adjust their portfolios

Example: Company D in 2018 has a net profit of ###million, with 40 million shares outstanding. EPS = $1, stock price around $40.

In 2019-2020, net profit remains ###million, but the company repurchases 20 million shares. Now, EPS = (million ÷ 20 million = $2. Stock price could potentially double )(.

The link between EPS and revenue: Growth pipeline

To understand a company’s profitability potential, what is EPS is just the beginning. You need to track revenue )Revenue each period.

Typically, higher revenue results in higher net profit, which boosts EPS, and the stock price follows suit.

Chain reaction: Revenue ↑ → Net Profit ↑ → EPS ↑ → Stock Price ↑

However, it is important to distinguish whether the company earns profits from core business activities or from selling assets land, factories, offices. In the latter case, even if EPS increases, the stock may not be worth investing in because the company is in decline.

The relationship between EPS, dividends, and the company’s financial situation

Dividends are profits shared with shareholders. The market often uses dividends as an indicator of a company’s financial health:

• If the company is doing well: It will pay dividends
• If the company is struggling: Dividends will decrease or be eliminated

Companies that consistently pay or increase dividends over years are usually financially stable and well-managed. This fosters long-term investor trust.

P/E ratio: A measure of the true value of a stock

P/E = Stock Price ÷ EPS Earnings Per Share

This ratio shows how much you need to pay to earn the company’s profit.

• High P/E > 25: Overvalued stock; high growth expectations
• Low P/E < 12: Undervalued stock; potential bargain or company in trouble

Note that different industries have different typical P/E ranges. For example, tech stocks tend to have higher P/E ratios than traditional sectors.

Share repurchase: An optimal way to boost EPS

Share buyback is a strategic tool for companies to enhance stock value without significantly increasing profits. By reducing the number of shares outstanding, EPS will increase assuming net profit does not decrease.

This benefits current shareholders because:

• Their shares become more valuable
• They can realize gains or rebalance their portfolios

Important notes when using EPS indicators

Do not rely solely on 1-2 years of data

EPS is a useful short-term indicator, but what is EPS if not viewed in a long-term context? A company might temporarily boost EPS by selling assets or cutting management costs, but this does not reflect the company’s true health.

For example: A loss-making company that sells factories or land can generate “fake” profits. EPS may rise, but the company is actually in decline. Investors who understand this will avoid such stocks.

EPS increase ≠ Positive cash flow

A common trap: EPS increases while cash flow Cash Flow is negative.

A typical example is Netflix. Its EPS has been rising steadily for years, creating an image of a highly profitable company. However, Netflix faces a major issue: cash flow shortages and increasing debt. In other words, despite “book profits,” the company does not have real cash to operate.

Lesson: Always check operating cash flow Operating Cash Flow alongside EPS. Positive cash flow is a true indicator of financial health.

Conclusion

Understanding what eps is and how to use it is an essential skill for any investor aiming for stable profits in the stock market. However, do not rely solely on one indicator. Combining EPS with revenue, dividends, P/E, cash flow, and long-term company trends will help you make smarter investment decisions.

Remember: Good figures today do not guarantee profits tomorrow. Careful analysis, thorough planning, and patience for long-term results are the keys to success in stock investing.