5 Essential Rules for Choosing Growth-Potential Stocks Based on EPS Ratio

Understanding How to Calculate EPS - The Starting Point for Investors

When entering the stock market, the first question from any investor is: how to determine if a stock is truly worth it? The EPS (Earnings Per Share) - also known as profit per share - is the most basic tool to answer this question.

The EPS calculation is quite simple: EPS = (Net Income - Preferred Dividends) / Total Outstanding Shares

Essentially, EPS reflects the profitability of each share. If a company generates a lot of profit but distributes few shares, each share will have a higher value. Conversely, if profits are divided among many shares, the value per share will be lower.

From Theory to Practice: How the EPS Indicator Reflects Business Health

To understand better, consider the following specific case:

In 2020, Company A reported a net profit of $1,000 with 1,000 shares outstanding. So, EPS = $1 $1.00 per share(. One year later, revenue increased and net profit rose to $1,500, but the number of shares remained the same. At that point, EPS increased to $1.50 - a 50% increase compared to the previous year.

What does this number indicate? It shows that the company is becoming more efficient, generating more profit for each investor. In the long run, the market will expect the stock price to increase accordingly.

However, there is an important point to remember: Short-term EPS growth )less than 1 year( does not necessarily lead to an increase in stock price. Short-term stock prices are heavily influenced by market sentiment. If investors are optimistic, capital flows into stocks, and prices rise. If pessimistic, the market declines, and prices fall — this phenomenon can last 6-12 months. But in the long term )over 5 years$40 , increasing EPS will be a strong signal of stock price growth.

Building a Stock Selection Strategy: Combining Multiple Indicators

Relying solely on EPS is not enough. Smart investors need to combine multiple analysis tools to increase accuracy:

High EPS: A company with high profit per share is a positive sign.

Stable Business Operations: Track EPS trends over many years. If EPS increases consistently, the company is developing sustainably.

Stable and Growing Dividend Policy: If a company not only makes profits but also pays stable dividends to shareholders, that’s a good sign. McDonald’s is a typical example — for 43 years, their dividends have increased steadily, attracting more investors.

Reasonably Low P/E Ratio: P/E = Stock Price ÷ EPS. If P/E > 25, the stock may be overvalued. If P/E < 12, it could be a buying opportunity. However, standards vary across industries, so compare within the same sector.

Share Buyback Policy: Some companies buy back their own shares from the market. This action reduces the number of shares outstanding, automatically increasing EPS. With the same profit, dividing by fewer shares results in higher EPS.

Illustration example: Company AAA has a profit $40 and 40 shares outstanding, EPS = $1, stock price around $40/share. If the company repurchases 20 shares, EPS becomes (÷ 20 = $2, and the stock price could double to $80.

Revenue - The Foundation of All Indicators

To evaluate a company accurately, EPS alone is not enough. You need to look at revenue )Revenue( — the total money the company earns from its core operations.

Related formula: Total Revenue - Total Expenses - Corporate Tax = Net Profit After Tax

Generally, a company with large and continuously increasing revenue will have high profits, leading to high EPS and rising stock prices. Revenue is the “money-making machine” of the company, serving as the basis for generating real profits.

An important point: some companies may have high profits due to selling assets )land, factories### rather than from core business activities. Therefore, analyzing revenue helps investors understand where the company is earning its money from.

Important Warnings: Not All EPS Growth Is Good

Avoid Judging Based on 1-2 Years

EPS can temporarily increase due to unhealthy reasons. For example, a company sells assets to boost profits, causing EPS to rise in that reporting period, but core operations decline. If you only look at 1-2 years, you might be “fooled.”

Solution: Always look at the EPS trend over at least 5 years or more. If EPS increases steadily over many years, that’s a reliable sign.

( Cash Flow )Cash Flow( — The True Indicator of Financial Health

A big warning: EPS growth does not mean the company actually has cash. Netflix )NFLX is a clear example. Netflix’s EPS has increased continuously over many years, but the company faces negative cash flow issues and rising debt. In other words, despite “book profits,” the company’s cash reserves are gradually depleting.

The lesson here: Always check the company’s real cash flow. If cash flow is negative or weak, be cautious, even if EPS looks impressive.

Conclusion: Use EPS as a Tool, Not the Only Solution

EPS is just the beginning, not the end. Wise investors will combine EPS with revenue, dividends, P/E, cash flow, and many other indicators to make decisions. Calculating EPS may be easy, but using it to generate profits requires skills and deep knowledge. Be patient, analyze thoroughly, and never invest based on a single indicator.