5 Criteria for Choosing Promising Stocks: Practical Investment Guide with EPS Calculation Formula

Starting with the EPS calculation formula: The foundation for choosing good stocks

To succeed in stock investing, you need to understand how a business generates profit. The EPS formula (Net income - Preferred dividends) / Outstanding shares is the key to helping investors measure the actual business performance of each company.

Simply put, EPS is the profit each share brings to investors. If a company’s net profit increases but the number of shares outstanding remains unchanged, EPS will rise accordingly, reflecting better profitability of the business.

Understanding the relationship between EPS, revenue, and stock price

In 2020, Company A had a net profit of $1,000 with 1,000 shares outstanding, EPS = $1. By 2021, profits increased to $1,500 but the number of shares remained the same, EPS rose to $1.5 – a 50% increase. This indicates that the business operations are becoming healthier.

However, the relationship between EPS and stock price is not always linear, especially in the short term. When the market is optimistic, capital flows strongly into stocks, and stock prices rise regardless of EPS. Conversely, when investors panic, they flee risky stocks even if the index is good.

The key difference: Over one year, market psychology dominates. But over 5 years or more, steady EPS growth usually pulls stock prices upward.

Revenue is a more reliable criterion for evaluating potential

Instead of just looking at EPS for one year, check the company’s annual revenue trend. The formula: Total revenue - Total expenses - Taxes = Net profit. When revenue grows steadily, profits increase, EPS rises, and ultimately stock prices follow.

An important tip: Some companies report high profits from selling assets (land, factories, buildings) rather than from core operations. These profits are not sustainable. You need to compare annual revenue to distinguish “real profit” from “fake profit.”

Dividend policy reveals the company’s true financial health

When a business is performing well and making a profit, it usually pays dividends to shareholders. The dividend level reflects management’s confidence in the future. The market views dividends as a signal: Does the company have enough cash to distribute profits to shareholders?

McDonald’s is a typical example. Over 43 years, McDonald’s revenue and dividends have increased steadily, attracting more and more new shareholders. This demonstrates the long-term appeal of a genuine business.

P/E ratio: A tool to assess whether a stock is “expensive or cheap”

The P/E formula = Stock price ÷ EPS tells you how much you are paying for each unit of profit. A high P/E (>25) indicates an expensive stock, with high growth expectations. A low P/E (<12) could be a golden opportunity or a sign that the market lacks confidence in the company.

Note: Different industries have different P/E standards. Technology usually has high P/E, while consumer sectors are lower. Comparing within the same industry is essential for meaningful analysis.

Share buyback strategy: How companies “boost profits”

Some companies buy back their outstanding shares from the market and cancel them. Why? Because this reduces the number of shares outstanding, causing EPS to automatically increase even if profits stay the same.

Example: In 2018, Company AAA earned $40 with 40 shares outstanding, EPS = $1, stock price ~ $40. In 2019, profits remain $40 but the company repurchases 20 shares, leaving 20 shares outstanding. Now EPS = 40 ÷ 20 = $2, and the stock price could jump to $80.

This is a legal strategy, but investors should be cautious: share buybacks are good only if the company has surplus cash and is not borrowing to do so.

Three pitfalls when using the EPS calculation formula

Pitfall 1: Relying on EPS over 1-2 years
EPS growth over 1-2 years doesn’t prove much. A company might sell assets to boost profits, but its core operations could be losing money. You need to look at 3-5 years to see the true trend.

Pitfall 2: Forgetting to check cash flow (Cash flow)
Netflix is a warning case. EPS has increased for many years, but the company is burning cash to produce content, with increasing debt. Accounting profits rise, but cash runs out. When cash flow is negative, the stock becomes a slow-moving bomb.

Pitfall 3: Not combining multiple indicators
Using EPS alone is very risky. Combine it with: steady revenue growth, stable or increasing dividends, reasonable P/E, positive cash flow, and smart buyback strategies. The more favorable conditions, the higher the probability of selecting a good stock.

Conclusion: From theory to action

No single EPS formula is simple and perfect. The secret is to combine EPS, revenue, dividends, P/E, cash flow, and buyback policies to get a comprehensive picture. Professional investors always analyze a business from multiple angles, never relying on a single indicator. Start learning to read quarterly financial reports, follow long-term trends, and always ask: “Where does the company really make money from?”