Detailed Guide on How to Calculate EPS and 5 Criteria for Selecting Promising Stocks

2025-12-26 11:21:45

Getting Started with a Real-Life Example of the EPS Indicator

To understand how to calculate EPS and its importance, let’s consider a specific case:

In 2020, Company A had a net profit of $1,000 with 1,000 shares outstanding. Applying the EPS = Net Profit ÷ Number of Shares Outstanding formula, we get EPS = $1 for each share.

In 2021, net profit increased to $1,500 but the number of shares remained unchanged. At this point, EPS = $1.5, a 50% increase compared to the previous year. This figure indicates that the business is performing better, generating abundant profits. However, market stock prices do not always immediately reflect this increase, especially in the short term when market sentiment fluctuates.

What Is EPS and How Is It Calculated?

Earnings Per Share (EPS) ( is a tool to evaluate the profitability of each share, helping investors understand a company’s operational efficiency.

Basic formula:

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

Or a simpler approach:

Net Income After Tax = Total Revenue - Total Expenses - Corporate Tax

When revenue increases and costs are well-controlled, net profit after tax will be higher, leading to an increase in EPS, which generally correlates with a long-term rise in stock prices.

The Relationship Between EPS, Revenue, and Stock Price

Revenue )Revenue( is an important indicator to determine a company’s actual business capacity. A company may own many assets )land, factories, real estate(, but if revenue from core operations does not grow, EPS may disappoint.

Direct relationship:

Revenue growth → Increase in net profit after tax → EPS growth → Stock price tends to rise

For long-term investors, monitoring quarterly/annual revenue trends is the first and most crucial step.

What Does Dividend Reflect About EPS?

Dividends are the portion of profits distributed to shareholders. The market often views dividend payments as a sign that the company is operating well and profitable. A sustainable growth company typically pays stable dividends with a tendency to increase annually.

For example, McDonald’s has maintained revenue and dividend growth for 43 years, with a continuously increasing number of shareholders. This demonstrates that combining rising EPS with stable dividend policies creates long-term appeal for investors.

P/E Ratio and How to Value Stocks

Price-to-Earnings Ratio (P/E) ) is calculated as:

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

This ratio indicates how much investors need to pay to “buy” one unit of the company’s profit. In other words, P/E measures the payback period:

P/E > 25: Stock price is overvalued; caution advised before buying
P/E < 12: Stock price is undervalued; potential buying opportunity

However, “high” or “low” P/E levels should be considered within the context of each industry and market, as different sectors have varying risk and growth characteristics.

Share Repurchase Strategy and Its Impact on EPS

When a company repurchases its outstanding shares, the number of shares outstanding decreases. This has the effect of increasing EPS without needing to increase absolute profits.

Illustrative example:

In 2018, Company AAA had a net profit of ( million and 40 million shares outstanding → EPS = $1, with a stock price around $40.

In 2019-2020, profits remained at ) million, but the company decided to buy back 20 million shares. Then:

New EPS = ( million ÷ 20 million shares = ) per share
Stock price could potentially rise to $80, doubling in value

However, note that share buybacks are positive signals only if the company has surplus cash and believes its stock is undervalued. If the company borrows money to buy back shares, it could be a warning sign.

5 Criteria for Selecting Promising Stocks Based on EPS

To increase the likelihood of high returns, investors should combine multiple indicators rather than rely solely on EPS:

Criteria	Requirements
EPS	High and trending upward
Business operations	Stable, with continuous revenue growth
Dividend payout ratio	Stable and increasing annually
P/E ratio	Low relative to intrinsic value, not excessively high
Buyback policy	Has plans to repurchase shares when prices are reasonable

The more criteria combined, the higher the chance of selecting good stocks.

Important Notes When Using the EPS Indicator

( Do Not Evaluate EPS Based on Only 1-2 Years

An increase in EPS is not always a positive signal in the short term. A company might sell assets like land or factories to generate one-time profits, causing EPS to rise on paper but main business operations to decline. Therefore, investors should analyze EPS over a long-term period )3-5 years or more$40 to accurately assess true trends.

$40 EPS Increase Does Not Equal Strong Cash Flow

Netflix $40 NFLX$2 is a typical example. The company’s EPS has increased steadily over many years, but its ###cash flow( has not kept pace, and debt levels have risen. This means high paper profits but limited actual cash flow.

Cash flow is the most “vital” indicator — it shows how much real money the company has. If EPS increases but cash flow is negative, it’s a red flag that the company may face difficulties in the future.

) Balancing Different Indicators

No single indicator is perfect. For safe investing, combine EPS analysis with revenue, profit margins, cash flow, debt levels, and other industry factors. Only when all indicators show positive signals should the stock be considered truly suitable for long-term investment.

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