In-depth analysis of earnings per share: Master the EPS formula and stock selection logic

What is Earnings Per Share (EPS)

The full English term for EPS is Earnings Per Share. This term relates a company’s profit to the number of shares outstanding, reflecting the amount of profit allocated to each common share in the company’s operations. In simple terms, the higher the EPS, the more profit each share generates.

In financial analysis, EPS is a core indicator of a company’s profitability. For investors, it answers a key question: how much profit can I earn per dollar invested relative to the stock price? Because of this, institutional and individual investors widely use EPS as a valuation tool. Additionally, investors compare EPS levels across different companies to assess which enterprise has more competitive profitability.

By observing Apple Inc. (AAPL.US) over the past 20 years, we can see that as the company’s scale expands and market position solidifies, its EPS continues to rise, truly reflecting the increasing value of the company year by year.

Understanding the EPS Formula and Calculation Method

Components of the EPS Formula

The standard formula for calculating EPS is:

EPS = (Net Profit - Preferred Dividends) ÷ Weighted Average Number of Common Shares Outstanding

The three elements in this formula serve specific roles:

• Net Profit refers to the company’s total revenue minus all operating expenses, usually listed at the bottom of the income statement.
• Preferred Dividends are fixed dividends paid to preferred shareholders, also clearly recorded in the income statement.
• Weighted Average Number of Common Shares Outstanding is the number of issued common shares minus treasury shares, available in the shareholders’ equity section of the balance sheet.

Practical Example: Extracting Data from Financial Statements

Taking the 2022 financial report of Bank of America (BAC.US) as an example:

Step 1: Locate “Net Earnings” of $27.528 billion and “Preferred Dividends” of $1.513 billion in the income statement.

Step 2: Find the “Weighted Average Number of Shares Outstanding” as 8.1137 billion shares.

Step 3: Plug into the formula: Bank of America EPS = ($27.528 billion - $1.513 billion) ÷ 8.1137 billion = $3.21

It is worth noting that financial reports usually provide EPS already calculated and directly presented, so investors typically do not need to compute it manually.

Official Methods to Check EPS

Method 1: Directly Review the Company’s Financial Reports (Most Accurate)

For example, Apple Inc.: Visit the U.S. Securities and Exchange Commission (sec.gov), use the EDGAR search function, input “10-K” (annual report) or “10-Q” (quarterly report) and the company code, then find “Earnings per Share” in the “Consolidated Statements of Operations.”

Method 2: Use Financial Information Websites (Convenient but May Have Delays)

Platforms like SeekingAlpha, Yahoo Finance provide free EPS data, but users should distinguish between basic EPS and diluted EPS, among other types.

Core Strategies for Stock Selection Using EPS

Tracking Long-term EPS Trends

Single quarter or annual EPS data lack meaningful reference. The key is to observe the company’s EPS trend over multiple years. If a company’s EPS increases year after year, it indicates sustained profitability and is a relatively safe investment target. Conversely, companies with shrinking or highly volatile EPS should be approached with caution.

Long-term EPS growth reflects the company’s intrinsic growth momentum and competitive advantage in the market. Such companies often have higher investment value. On the other hand, a continuous decline in EPS suggests operational difficulties, potentially suppressing returns.

Horizontal Comparison: Comparing EPS Among Industry Peers

Besides tracking vertically over time, investors can compare a target company’s EPS with that of industry peers. Higher EPS generally indicates more efficient profit generation per unit compared to competitors.

However, this should be combined with Price-to-Earnings Ratio (P/E Ratio) for deeper analysis: P/E Ratio = Stock Price ÷ EPS. For example, if Company A’s stock price is $30 and EPS is $1, its P/E ratio is 30. If the industry average P/E is 10, it suggests that Company A’s stock price is inflated relative to earnings, possibly indicating a valuation bubble. It also reflects market optimism about the company’s future growth.

Limitations and Pitfalls of Using EPS for Stock Selection

Historical Cases: High EPS Does Not Guarantee High Returns

For example, in the semiconductor industry, after 2020, Qualcomm (QCOM.US) had EPS far ahead of NVIDIA (NVDA.US) and AMD (AMD.US). If selecting stocks solely based on EPS, Qualcomm would seem the best choice. However, over three years, NVIDIA’s stock price increased by 251%, while Qualcomm’s only rose by 69%. This illustrates that EPS does not necessarily correlate directly with actual stock price performance.

Three Major Pitfalls of EPS

Pitfall 1: Stock Buyback Effects
When a company repurchases its own shares, the number of shares outstanding decreases. If net profit remains unchanged, the denominator shrinks, artificially boosting EPS and potentially misleading investors about profitability.

Pitfall 2: Distortion from Special Items
One-time items such as asset sales, restructuring losses, or tax benefits can distort net profit and thus EPS. Investors should exclude these extraordinary items and focus on EPS from ongoing operations.

Pitfall 3: Ignoring the Overall Financial System
EPS reflects only one dimension of profitability. Factors like cash flow, debt levels, industry outlook, and management decisions also determine investment value. Relying on a single indicator cannot provide a complete investment decision basis.

Interaction Between EPS and Other Financial Indicators

The Positive and Negative Feedback Loop Between EPS and Stock Price

Generally, strong EPS tends to drive stock prices higher. The reasoning: robust EPS boosts market confidence → increased investor buying → rising stock price → enhanced company reputation → sales growth → further EPS growth. This creates a virtuous cycle.

However, this relationship is not absolute. If the market expects EPS of $2 but the company reports $1.5, despite EPS growth quarter-over-quarter, the stock price may decline because the market prices in the expectation gap.

Difference Between EPS and Dividends Per Share (DPS)

Dividends Per Share (DPS) is calculated as: Total Dividends Paid ÷ Number of Shares Outstanding
Dividend Yield is calculated as: DPS ÷ Stock Price

EPS measures the total profit generated per share, while DPS indicates the portion of profit returned to shareholders. They reflect different aspects of shareholder returns.

High dividend payments imply the company distributes most of its profits to shareholders rather than reinvesting or expanding. Growth companies in tech and biotech sectors often retain more earnings for innovation, resulting in lower or zero DPS. During economic downturns, investors tend to prefer stable companies with high yields.

EPS and Corporate Operational Decisions

Special items in financial reports significantly impact EPS. For example, a restaurant chain selling property might record a large gain, boosting current net profit, but this is not from ongoing operations. Investors should focus on “adjusted EPS” excluding such special items, which better reflects the company’s true operational capability.

Key Differences Between Basic EPS and Diluted EPS

Definition and Calculation of Diluted EPS

Diluted EPS considers all potential common shares from convertible securities and is calculated as:

Diluted EPS = (Net Profit - Preferred Dividends) ÷ (Weighted Average Common Shares + Convertible Dilutive Securities)

For example, Coca-Cola (KO.US) in 2022: net profit of $9,542 million, 4,328 million shares outstanding, and 22 million convertible dilutive securities.
Diluted EPS = $9,542 ÷ (4,328 + 22) = $2.19

The Practical Difference Between the Two EPS Types

Basic EPS shows the company’s current true earnings level, while diluted EPS indicates potential dilution if all convertible instruments are exercised. Investors should monitor both to fully assess potential impacts on shareholder value.