Earnings per share or EPS is the profit after tax of a company divided by the total number of shares outstanding. EPS is the measure of profitability of a company; higher the EPS better is the profitability. EPS is reported on a quarterly basis, when companies release their financial statements. Fund managers and analysts look at EPS very carefully, when selecting stocks for investments because EPS growth is the most important factor in share price appreciation.
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Various factors like mergers and acquisitions, divestitures, spin-offs etc can impact EPS; analysts normalize reported EPS numbers so that they can make like to like comparisons for year on year or quarter on quarter EPS growth. Apart from EPS growth fund managers and analysts place a lot of importance to earnings visibility. Many companies also provide guidance on future EPS growth but companies may not be able to provide near term or medium term guidance during economic downturns. Apart from management guidance, analysts also try to analyze EPS growth to various factors like:-
- Is it due to growth in sales?
- Is it due to improvement in operating margins?
- Pricing power of the company
- Market share
- Increase or decrease in financial leverage (debt / equity ratio)
- Share buybacks etc
Companies which show consistently high EPS growth and have good earnings visibility are favored by investors.
