Guide to using the EPS ratio to select good stocks

What is EPS and Why Do Investors Need to Pay Attention?

If you are exploring stock investing, the (Earnings Per Share) (EPS) is one of the essential analysis tools you cannot ignore. This indicator shows the profit generated by each share for shareholders.

The calculation formula for EPS is quite simple:

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

Or it can be understood as: Net Profit After Tax = Total Revenue - Total Expenses - Corporate Income Tax

This indicator helps you assess whether a company is truly profitable and to what extent.

How EPS Affects Stock Prices

Suppose in 2020, Company X has a net profit of $1000 with 1000 shares issued, EPS = $1.

In 2021, profits increase $1500 but the number of shares remains unchanged, EPS rises to $1.5, a 50% increase. This is a positive signal, indicating the business is growing.

However, note that an increase in EPS does not necessarily lead to an immediate rise in stock price. In the short term (less than 1 year), stock prices are more influenced by market sentiment:

• When the market is optimistic: capital flows in, stocks rise
• When the market is pessimistic: investors withdraw capital, stocks fall

But in the long term (5 years or more), sustainable EPS growth will pull the stock price up accordingly.

Combining EPS with Other Indicators

To make sound investment decisions, do not rely solely on EPS. It should be combined with other indicators:

• P/E Ratio (Price-to-Earnings): The ratio of stock price to EPS. A high P/E (>25) indicates the stock is overvalued, while a low P/E (<12) presents a good buying opportunity.
• Revenue (Revenue): The larger the company’s revenue, the higher its net profit tends to be, leading to higher EPS.
• Dividends (Dividend): If a company regularly pays dividends and has a trend of increasing them, it signals good financial health.
• Share Buyback Policy: When a company repurchases its outstanding shares, the number of shares decreases, automatically increasing EPS even if profits remain unchanged.

Example: Company AAA has a profit $40 with 40 shares, EPS = $1. If it repurchases 20 shares, EPS will rise to $2, potentially doubling the stock price.

Common Pitfalls When Reading EPS

Do not evaluate based on just 1-2 years

EPS only reflects current business performance and does not reveal how the company makes money. A company might sell assets (land, factories) for profit, increasing EPS, but this does not mean the stock is worth investing in.

Check cash flow

An increasing EPS is not always a good sign. Netflix, for example, had continuous EPS growth but faced cash flow issues, rising debt, and dwindling capital. Therefore, always check the company’s actual (cash flow).

The Complete Toolkit for Selecting Potential Stocks

The more indicators you apply, the higher the probability of profit:

✓ High and stable EPS ✓ Sustainable business operations ✓ Stable and increasing dividend payout ratio ✓ Reasonable P/E ratio (not too high) ✓ Company has a share buyback policy

Understanding EPS and how to combine it with other indicators is the first step toward building an effective long-term stock investment strategy.