What is a good EPS ratio? 5 principles for selecting potential stocks for investors

Understanding the EPS Ratio - The Foundation of Investment Decisions

Earnings Per Share (EPS) is a tool for evaluating the profitability that each share can generate. The nature of this ratio reflects the operational efficiency of the business. The calculation formula:

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

Where, net profit after tax = Total revenue - Total expenses - Corporate income tax

To illustrate, in 2020, Company A had a net profit $1000 with 1,000 shares issued, EPS = $1. In the following year, 2021, revenue increased $1500 but the number of shares remained the same, EPS rose to $1.5 (a 50% increase). This indicates that the profitability per share has improved significantly.

The correlation between rising EPS and stock prices in the short-term and long-term

Market factors play a key role in short-term stock price movements. When the market is optimistic, capital flows into investment channels such as stocks and real estate, causing stock prices to rise. Conversely, pessimistic sentiment causes investors to avoid risky investments, leading to price declines over 6 months to 1 year.

However, in the long-term (over 5 years), increasing EPS is the main driver pushing stock prices higher. Therefore, the EPS ratio being good or not is not evaluated in isolation but by monitoring sustained growth trends.

Combining EPS with other business indicators

To increase the probability of profit, investors should analyze a comprehensive set of indicators:

• Stable business operations: Consistent revenue growth without excessive volatility
• Stable and increasing dividends: Paying dividends indicates good financial health. McDonald’s is a typical example - revenue and dividends have increased continuously for 43 years
• Reasonable P/E ratio: P/E = Stock Price ÷ EPS. P/E > 25 is considered high, P/E < 12 is considered low. This ratio helps determine if a stock is overvalued or undervalued
• Share repurchase policy: When a company repurchases its outstanding shares, the number of shares decreases, naturally increasing EPS

The relationship between revenue and EPS

Revenue (Revenue) is an independent indicator that helps distinguish actual profit from core operations versus profit from asset sales. A company selling factories due to losses can still show increased EPS on paper, but it’s not a reason to invest.

The general rule is: Total revenue increase → Net profit after tax increase → EPS increase → Stock price increase

Warning: Increasing EPS is not always good

A common mistake is evaluating EPS over only 1-2 years. Netflix (NFLX) is a typical example - EPS has increased for many years, but cash flow (cash flow) has declined, and debt has skyrocketed. In other words, paper profits do not match actual cash.

Therefore, it’s essential to analyze cash flow carefully before making decisions. How good an EPS ratio is depends on the industry and sustainable growth trends, not just the absolute number.

Summary: The process of selecting potential stocks based on EPS

When aiming to participate in the stock market with long-term profit goals, you should:

1. Check if EPS has an increasing trend over 5+ years
2. Ensure revenue growth accompanies EPS growth
3. Confirm the company pays stable dividends
4. Compare P/E with the industry average
5. Evaluate actual cash flow to avoid “fake profits”

Understanding these factors will help you make smarter investment decisions.