What EPS growth actually tells investors
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Investors and market analysts often mention the term ‘EPS growth’ when discussing a company’s performance, whether it’s doing well, expanding, and even creating value for its shareholders. While it is a widely used financial metric within said community, it is also one of the misunderstood measures.
What is EPS and EPS growth?
Earnings per share, or EPS, pertains to the portion of a company’s profits allocated to each share of outstanding stock. It is one of the key profitability metrics reported by publicly listed companies. Under accounting standard IAS 33, companies reporting under IFRS are required to disclose both basic and diluted EPS in their financial statements. Reporting both figures allows investors to compare profitability across different businesses and periods.
The formula for basic EPS is:
EPS = net income available to ordinary shareholders/ weighted average number of outstanding shares.
On the other hand, EPS growth measures the rate at which earnings per share increase over a specific period. It is expressed as a percentage
For example, if a company reports EPS of £1.00 one year and £1.20 the following year, EPS growth would be: ((1.20 − 1.00) ÷ 1.00) × 100 = 20%. This indicates that earnings attributable to each share increased by 20% during that period.
How is EPS growth calculated?
There are several methods investors use when evaluating EPS growth, including the following:
Year-on-year growth
The calculation shown earlier is based on this method, where the EPS from a year is compared to the EPS from the previous year. This method is used to identify short-term changes in profitability.
Compound Annual Growth Rate (CAGR)
For longer periods, investors often calculate the compound annual growth rate. CAGR smooths fluctuations and shows the average annual growth rate over several years. For example, if EPS rises from £1.50 to £3.00 over five years, CAGR can provide a clearer picture of the underlying trend than simply comparing the starting and ending figures.
Forward EPS growth
Analysts frequently estimate future EPS growth based on earnings forecasts. While forward-looking estimates can provide insight into expectations, they rely on assumptions that may not materialise. Forecasts should therefore be interpreted cautiously.
What do these numbers reveal about a company?
EPS growth can reveal several important aspects about the company’s financial standing:
- Profitability: Naturally, when revenues grow faster than expenses, profits are greater, and that could contribute to higher earnings per share.
- Operational efficiency: Companies that manage to curb operational costs while expanding revenue usually achieve stronger EPS growth over time.
- Effective capital allocation: Businesses that invest wisely in growth opportunities can produce greater earnings without diluting shareholders. Effective investment decisions can contribute to sustainable earnings growth over time.
- Improved market perception: Companies that deliver higher earnings attract attention from potential investors.
That said, EPS growth should never be viewed in isolation: a single year’s increase may be a result of temporary, one-time factors rather than deliberate and sustainable business decisions.
But what factors contribute to rising earnings per share?
Revenue growth
One of the most direct drivers is increasing revenue. Higher revenue and profits are often attained when a company successfully expands its customer base, enters new markets, or launches successful product lines.
Margin expansion
Businesses can also improve EPS by increasing profit margins. This may occur through cost reductions, operational efficiencies, or improved pricing power.
Share buybacks
A company can increase EPS by repurchasing its own shares. Because EPS divides earnings by the number of outstanding shares, reducing the share count can increase earnings per share even if total profits remain unchanged. This is one reason investors often examine both earnings growth and revenue growth together.
Lower financing costs
Reduced interest expenses can improve net income, supporting EPS growth. This occurs when companies refinance debt at lower rates or reduce borrowing levels.
Tax changes
In addition, changes in corporate tax rates can influence earnings. A lower effective tax rate may boost reported profits and contribute to EPS growth.
Basic EPS vs Diluted EPS
When reviewing earnings reports, investors will often encounter both basic EPS and diluted EPS.
Basic EPS uses the weighted average number of ordinary shares outstanding during the reporting period and reflects the company’s profitability based on existing shareholder ownership. On the other hand, diluted EPS accounts for potential ordinary shares that are created through instruments such as stock options, convertible bonds, and even employee share plans. As these additional shares increase the total share count, diluted EPS is usually lower than basic EPS.
Of the two measures, a lot of analysts regard diluted EPS to be a more conservative measure because it can reflect the impact of a potential future share dilution.
EPS growth as a component of market analysis
EPS growth is most valuable when analysed alongside broader financial data. Revenue trends, cash flow, balance sheet strength, and competitive positioning can all provide additional context that helps create a more complete picture of corporate performance.
For traders using Contracts for Difference (CFDs), understanding earnings-related metrics can support broader market analysis. Although CFDs track the price movement of underlying assets rather than providing ownership of shares, company earnings announcements and EPS growth figures can still influence market volatility and price action.
Limitations of EPS growth
While EPS growth is a valuable metric, it has several limitations. Different accounting methods can affect reported earnings, which makes comparisons between companies more complex. EPS also focuses on historical performance rather than future prospects.
Furthermore, businesses operating in cyclical industries may experience significant earnings fluctuations due to economic conditions rather than company-specific factors. For this reason, investors frequently combine EPS analysis with other financial measures like revenue growth, return on equity, free cash flow, and debt levels.
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Frequently asked questions (FAQs)
There is no universal benchmark. EPS growth should be evaluated relative to the company's industry, business model, and historical performance. Consistency and sustainability are often more important than a single year of rapid growth.
Diluted EPS includes the impact of potential shares that could be issued through stock options, convertible securities, and other instruments. This increases the share count and typically reduces earnings per share.
Yes. EPS can increase through cost reductions, share buybacks, lower interest expenses, or tax benefits. However, investors often examine whether earnings growth is supported by wider business improvements.
