How deep are the pitfalls of EPS stock selection? Understand the true nature of earnings per share in this article

Why Are Investors Focused on EPS?

What exactly is Earnings per share (EPS)? Simply put, it’s the amount of company net profit allocated to each common share. In other words, if you invest $1 in a stock, how much profit can the company generate for you—that’s what EPS tells you.

This indicator is widely watched by investors because it directly reflects the company’s profitability. The higher the EPS, the more profit the company is squeezing out of the same equity. When the market believes a company can generate more profit, investors are usually willing to pay a higher price for its stock. That’s also why many investors use EPS to compare the value of different companies—companies with higher EPS are generally seen as more attractive investments.

How to Calculate EPS? A Step-by-Step Guide

The formula for EPS is actually very straightforward:

EPS = (Net Profit - Preferred Dividends) / Number of Outstanding Common Shares

The three variables represent:

• Net Profit: The company’s total revenue minus all expenses, usually found at the bottom line of the income statement
• Preferred Dividends: Fixed dividends paid to preferred shareholders, also listed on the income statement
• Number of Outstanding Common Shares: The total issued common shares minus treasury shares repurchased by the company, data from the balance sheet

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

Find net profit of $27.528 billion and preferred dividends of $1.513 billion, and obtain the weighted average number of shares outstanding as 8.1137 billion from the report. Plug into the formula:

Bank of America EPS = ($27.528 billion - $1.513 billion) / 8.1137 billion = $3.21

Honestly, investors generally don’t need to do this calculation themselves. Public companies already calculate EPS clearly in their financial reports, so just use those figures directly.

The Subtle Relationship Between EPS, Stock Price, and Dividends

Does EPS always move in the same direction as stock price?

In theory, strong EPS should boost stock prices, and vice versa. The logic of this positive correlation is: good earnings data boost investor confidence, attracting more buying, which drives the stock price up. Rising stock prices then reinforce the company’s market position, leading to sales growth and further EPS increases.

But in reality, there are often “face-slapping” situations. If a company reports EPS below Wall Street expectations, even if EPS is growing, the stock price may fall—because the market prices based on expectations. Similarly, if EPS declines but beats expectations, the stock may rebound. This reveals a harsh reality: Market expectations are often more important than actual data.

What’s the difference between EPS and dividends per share?

Dividends per share (DPS) = Total Dividends / Number of Shares Outstanding

Dividend Yield = DPS / Stock Price per Share

EPS measures how much profit the company generates per share, while DPS measures how much profit is actually distributed to shareholders. The key difference is: EPS is the company’s “profitability,” and DPS is the “dividend-paying capacity” for shareholders.

Many growth companies (especially tech stocks) have good EPS but low DPS because they reinvest most profits to expand their business. Conversely, some mature companies distribute more profits as dividends, resulting in higher DPS. High dividend yields often attract conservative investors because they provide immediate cash income and also imply the company is confident in its profitability.

Stock Picking Based on EPS: Watch Out for These Pitfalls

Many newcomers to the stock market get EPS wrong entirely. Common mistakes include:

Only looking at quarterly or annual EPS data

A single quarter or year’s EPS is meaningless; what matters is the trend. If a company’s EPS steadily grows year after year, it indicates genuine profit improvement, which is worth paying attention to. Conversely, if EPS fluctuates wildly or declines, be cautious.

Using EPS to directly compare companies in the same industry

Company A has EPS of $3, and Company B has EPS of $1—does that mean A is better? Not necessarily. Why? Because the number of shares outstanding differs. Company A might have repurchased a large number of shares, artificially boosting EPS. The correct approach is to look at the Price-to-Earnings ratio (P/E ratio): Stock Price divided by EPS. This metric better reflects valuation.

Ignoring the “black hand” behind EPS

This refers to activities like stock buybacks, asset sales, tax breaks, and other non-operational items. For example, a restaurant sells land and reports huge income, causing EPS to skyrocket. But this income isn’t from core operations and won’t recur next year. Savvy investors strip out these special items and focus on core profitability.

Case comparison: NVIDIA vs. Qualcomm

Look at the performance of three semiconductor giants: NVIDIA (NVDA.US), Qualcomm (QCOM.US), and AMD (AMD.US) from 2018-2023.

After 2020, Qualcomm’s EPS far exceeded the others, so based on EPS alone, one might favor Qualcomm. But in reality, NVIDIA’s stock price surged by 251% over these three years, while Qualcomm only rose 69%. Stocks selected solely by EPS can have disappointing returns.

What does this tell us? No single indicator can tell the whole story of a stock. EPS is just a reference; it must be combined with industry outlook, company strategy, competitive advantages, and other factors.

How to Check EPS? The Latest Methods

Check directly from official financial reports (most accurate)

For example, Apple (AAPL.US):

1. Visit the U.S. Securities and Exchange Commission website sec.gov, click “SEARCH EDGAR”
2. Enter search criteria: quarterly report 10-Q, annual report 10-K, company code AAPL, select time period
3. Open the relevant report, find “CONSOLIDATED STATEMENTS OF OPERATIONS,” and locate “Earnings per share”

This is the most direct method, providing the latest and most accurate data with high timeliness. The downside is it requires some ability to read English financial statements.

Check on financial info websites (convenient but delayed)

Platforms like SeekingAlpha, Yahoo Finance, etc., can provide free EPS data. Be aware that these sites offer multiple EPS types—basic EPS, diluted EPS, forecast EPS, TTM (trailing twelve months), etc. Investors need to understand which one they are viewing; usually, Basic EPS is the most relevant.

Basic EPS vs. Diluted EPS: Which Is More Worth Watching?

Most people only know about basic EPS but overlook the warning role of diluted EPS.

Basic EPS = (Net Profit - Preferred Dividends) / Current Outstanding Shares

This reflects the company’s current actual profitability.

Diluted EPS = (Net Profit - Preferred Dividends) / (Current Outstanding Shares + Convertible Securities)

Diluted EPS includes a “what if” scenario: if all convertible preferred shares, stock options, convertible bonds, etc., are converted into common shares, how much would EPS decrease?

For example, Coca-Cola (KO.US): Net profit of $9,542 million, 4,328 million shares outstanding, and 22 million convertible securities. Then:

Basic EPS = $9542 / 4328 = $2.21

Diluted EPS = $9542 / (4328 + 22) = $2.19

The difference is small, but if the number of convertible securities is large, the dilution effect can be significant. This warns investors that future EPS might be diluted.

FAQ: Common Investor Questions

Q: What EPS is considered good?

There’s no absolute “good” or “bad.” The key is the trend and comparison. If a company’s EPS rises every year, profitability is strengthening. Comparing with industry peers, higher EPS means more profit per investment. But EPS can be distorted by stock buybacks, special gains, etc., so don’t focus solely on the number.

Q: Can EPS be forecasted?

Yes. Wall Street analysts estimate future EPS based on company forecasts, market outlook, etc. Investors can compare actual EPS to forecasts to gauge market expectations—if actual EPS beats expectations, the stock often surges; if not, it may fall.

Q: Why do some companies have low EPS but their stock prices still rise?

Market pricing is based on expectations. If investors anticipate significant future growth, they are willing to buy even if current EPS is low. Conversely, if growth is expected to slow, stock prices may decline. This is why growth stocks often have high P/E ratios despite modest current earnings—they are priced for future growth.