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Earnings per share eps growth

What Is Earnings Per Share (EPS) Growth?

Earnings per share (EPS) growth is a key financial metric within the broader category of Financial Metrics that quantifies the rate at which a company's earnings per share have increased over a specified period. It indicates the percentage change in the profit a company generates for each outstanding share of its common shares outstanding63. A rising EPS growth typically signals improving profitability and can be a significant indicator for investors assessing a company's financial health and potential for increasing shareholder value60, 61, 62.

History and Origin

The concept of earnings per share (EPS) and its subsequent growth analysis emerged alongside the increasing sophistication of financial markets and corporate financial reporting. As public companies grew in size and complexity, investors needed standardized ways to evaluate their performance beyond raw profit figures. The formalization of accounting principles and the establishment of regulatory bodies played a crucial role. In the United States, the Securities and Exchange Commission (SEC), established in 1934 following the Great Depression, was tasked with restoring public confidence in financial markets by ensuring transparency and protecting investors57, 58, 59. The SEC mandated standardized financial disclosures, including the reporting of net income and the number of shares outstanding, which are the foundational components for calculating EPS56. This standardization made it possible for investors and analysts to consistently calculate and compare EPS, and subsequently, EPS growth, across different companies and over time.

Key Takeaways

  • EPS growth measures the percentage increase in a company's profit allocated to each outstanding share over time.
  • It is a widely used indicator of a company's historical and projected profitability.
  • Investors often seek companies demonstrating consistent and accelerating EPS growth.
  • Factors such as share buybacks, new share issuance, and accounting policies can influence EPS growth.
  • While important, EPS growth should be evaluated in conjunction with other financial metrics and a company's overall financial health.

Formula and Calculation

Earnings per share growth is calculated as the percentage change in EPS from one period to another. The basic formula for EPS itself is:

Earnings Per Share (EPS)=Net Income−Preferred DividendsWeighted Average Common Shares Outstanding\text{Earnings Per Share (EPS)} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Common Shares Outstanding}}

Once EPS figures for two periods are known, the EPS growth rate can be determined as follows:

EPS Growth Rate=(EPSCurrent PeriodEPSPrevious Period−1)×100%\text{EPS Growth Rate} = \left( \frac{\text{EPS}_{\text{Current Period}}}{\text{EPS}_{\text{Previous Period}}} - 1 \right) \times 100\%

For instance, to calculate the one-year EPS growth rate, the EPS from the most recent fiscal year would be compared to the EPS from the prior fiscal year54, 55. For a more conservative view, analysts often use diluted EPS, which accounts for the potential conversion of all dilutive securities into common stock52, 53.

Interpreting the EPS Growth

Interpreting EPS growth involves more than just looking at a single percentage. A strong, positive EPS growth rate suggests that a company is increasing its profitability on a per-share basis, which is generally viewed favorably by investors51. Consistent growth over multiple periods can indicate a stable and expanding business. However, it is crucial to consider the context. For example, EPS growth might be artificially inflated by share buybacks, which reduce the number of common shares outstanding and thus increase EPS even if net income remains flat48, 49, 50.

Conversely, modest EPS growth in a mature industry might be considered healthy, while the same rate in a high-growth sector could indicate underperformance. Analysts also compare a company's EPS growth to its industry peers and the broader market to gain perspective47. Understanding how changes in accounting policies or one-time events impact reported earnings is also vital for an accurate interpretation45, 46.

Hypothetical Example

Consider Tech Innovations Inc. For the fiscal year ending December 31, 2023, the company reported a net income of $10 million. It had 5 million common shares outstanding and paid no preferred dividends. Therefore, its EPS for 2023 was:

EPS2023=$10,000,0005,000,000 shares=$2.00 per share\text{EPS}_{2023} = \frac{\$10,000,000}{5,000,000 \text{ shares}} = \$2.00 \text{ per share}

For the fiscal year ending December 31, 2024, Tech Innovations Inc. reported a net income of $12 million. The number of common shares outstanding remained at 5 million. So, its EPS for 2024 was:

EPS2024=$12,000,0005,000,000 shares=$2.40 per share\text{EPS}_{2024} = \frac{\$12,000,000}{5,000,000 \text{ shares}} = \$2.40 \text{ per share}

To calculate the EPS growth from 2023 to 2024:

EPS Growth Rate=($2.40$2.00−1)×100%=(1.20−1)×100%=0.20×100%=20%\text{EPS Growth Rate} = \left( \frac{\$2.40}{\$2.00} - 1 \right) \times 100\% = (1.20 - 1) \times 100\% = 0.20 \times 100\% = 20\%

This indicates that Tech Innovations Inc. experienced a 20% EPS growth from 2023 to 2024, suggesting an increase in the company's per-share profitability.

Practical Applications

EPS growth is a cornerstone metric in various aspects of investment analysis and corporate finance.

  • Investment Decisions: Growth investors often prioritize companies with high and consistent EPS growth, viewing it as a strong indicator of future stock price appreciation43, 44. It's a key factor in many quantitative investment models.
  • Valuation: EPS is a critical component of widely used valuation multiples, such as the price-to-earnings ratio (P/E ratio). Analysts use current and forecasted EPS to determine if a company's stock is undervalued or overvalued41, 42.
  • Performance Evaluation: Management often focuses on achieving EPS growth targets, as this can influence executive compensation and market perception. Companies provide earnings guidance, although this practice has been debated due to potential pressure for short-term results40.
  • Financial Reporting and Regulation: Publicly traded companies are required to report EPS as part of their financial statements, specifically on the income statement. The U.S. Securities and Exchange Commission (SEC) closely monitors these disclosures to ensure transparency and prevent manipulation. The SEC, whose mission includes protecting investors and maintaining fair markets, plays a vital role in overseeing financial reporting standards38, 39.

Limitations and Criticisms

Despite its widespread use, EPS growth has several limitations that investors should consider. One significant criticism is that EPS can be manipulated through various accounting policies and financial maneuvers34, 35, 36, 37. For instance, a company can boost its EPS by repurchasing its own shares, thereby reducing the denominator in the EPS calculation, even if its underlying net income has not genuinely improved32, 33.

Furthermore, EPS growth focuses solely on reported earnings and does not always reflect the true cash flow generated by a business, which is essential for long-term sustainability and debt servicing30, 31. It can also be distorted by one-time events or non-recurring items, making it difficult to assess a company's ongoing operational performance27, 28, 29. The use of "non-GAAP" earnings measures, which exclude certain expenses, has also drawn scrutiny from regulators like the SEC, as these can present a more favorable but potentially misleading picture of profitability compared to measures adhering to Generally Accepted Accounting Principles (GAAP)25, 26. Critics also point out that EPS growth doesn't account for the level of debt or financial leverage a company might be using to achieve its growth, which could indicate higher risk22, 23, 24.

Earnings Per Share (EPS) Growth vs. Revenue Growth

Earnings per share (EPS) growth and revenue growth are two distinct but interconnected metrics vital for evaluating a company's financial performance. While EPS growth measures the increase in profit attributable to each share, revenue growth reflects the increase in a company's total sales or top-line income19, 20, 21.

The primary difference lies in what they represent: revenue growth indicates a company's ability to expand its sales and market presence, showing the demand for its products or services16, 17, 18. On the other hand, EPS growth indicates how effectively a company converts those sales into actual profits for its shareholders, after accounting for all expenses, including operating costs, interest, and taxes13, 14, 15.

For early-stage or high-growth companies, revenue growth might be considered more critical, as these companies may be investing heavily and prioritizing market share over immediate profitability11, 12. For more mature, established companies, consistent EPS growth is often a stronger indicator of financial health and efficient management10. A company can have strong revenue growth but stagnant or declining EPS if its expenses are growing faster than its sales, or if it issues a large number of new shares. Conversely, EPS can grow without significant revenue growth through cost-cutting measures or share buybacks. Therefore, analyzing both metrics together provides a more comprehensive view of a company's financial trajectory8, 9.

FAQs

Q: Is higher EPS growth always better?
A: Generally, higher EPS growth is viewed favorably as it suggests increasing profitability per share. However, it's essential to investigate the source of this growth. Growth driven by sustainable increases in revenue and efficient operations is more desirable than growth achieved through one-time gains, aggressive accounting policies, or significant share buybacks without underlying business improvement6, 7.

Q: How do analysts forecast EPS growth?
A: Analysts forecast EPS growth by analyzing a company's historical performance, industry trends, economic outlook, management guidance, and future expectations for revenue and expenses. These forecasts are crucial for investors using valuation models like the price-to-earnings ratio4, 5.

Q: What is the difference between basic EPS growth and diluted EPS growth?
A: Basic EPS growth considers only the common shares currently outstanding, while diluted EPS growth takes into account all potential shares that could be created from convertible securities, stock options, and warrants2, 3. Diluted EPS growth provides a more conservative estimate of future profitability per share, reflecting the maximum potential dilution of existing shareholder ownership.

Q: Can a company have negative EPS growth?
A: Yes, a company can experience negative EPS growth if its earnings per share decline from one period to the next. This could be due to lower net income, an increase in the number of outstanding shares, or a combination of factors. Negative EPS growth signals a decrease in per-share profitability and may indicate financial challenges for the company1.