The Relationship Between Earnings Per Share (EPS) and Stock Prices: A Must-Know Guide for Investors

When I first stepped into the stock market, one of the phrases I heard most often was, “In the long run, stock prices follow earnings.” At the time, I vaguely understood it to mean that when a company performs well, its stock price rises, and when performance falters, the stock price falls. But over time, I realized the core of this principle lies in Earnings Per Share (EPS). EPS is directly tied to profitability and plays a fundamental role in explaining stock price movements.

In this article, we’ll dive into what EPS is, how it is calculated, its relationship with stock prices, and how investors can use it in real-world decisions.

Table of Contents

1. What is EPS?

EPS represents the portion of a company’s profit allocated to each outstanding share of common stock. In simple terms, it tells us how much profit a single share of stock earns.

Formula:

For example, if Company A posts a net income of $100 million and has 100 million shares outstanding, its EPS is $1. This means each share represents $1 of profit.

Key Takeaways:

A higher EPS generally indicates greater profitability per share.
EPS is one of the most widely used indicators in corporate valuation.
It forms the foundation for other valuation ratios such as PER, PBR, and PSR.

2. The Relationship Between EPS and Stock Prices

While stock prices in the short term are influenced by market sentiment, news, and macroeconomic factors, in the long run they largely reflect a company’s earnings power. EPS is the numerical measure of that power, making its link with stock prices extremely important.

2.1 EPS and PER

Price-to-Earnings Ratio (PER) is calculated as Stock Price ÷ EPS.
This also means:

If EPS rises while PER stays constant, stock prices will naturally increase.
If EPS stagnates while PER declines, stock prices will drop.
If EPS falls along with PER, stock prices can tumble significantly.

2.2 EPS Growth Drives Stock Prices

Companies with steadily rising EPS usually see their stock prices trend upward over time. For instance, tech giants like Samsung or Apple have consistently increased EPS over many years, and their stock prices followed suit.

2.3 Short-Term Divergence

Sometimes stock prices deviate from EPS trends due to temporary shocks such as recessions, interest rate hikes, or geopolitical risks. But historically, stock prices tend to converge back toward EPS growth in the long term.

3. Types of EPS

Basic EPS
- The simplest measure, calculated as net income divided by common shares.
Diluted EPS
- Accounts for potential dilution from stock options, convertible bonds, and warrants.
- Provides a more conservative and realistic measure of profitability.
Forward EPS
- Based on projected earnings, often estimated by analysts.
- Crucial for valuing growth companies.

Investor Tip: Looking only at Basic EPS without considering Diluted or Forward EPS may lead to overestimating a company’s true value.

4. How to Use EPS in Investment Analysis

4.1 Tracking EPS Growth

Companies with consistently rising EPS are often stable, attractive investments. On the other hand, declining or volatile EPS can signal risk.

4.2 Comparing Across Industries

EPS should always be analyzed relative to industry peers. For instance, if one company’s EPS is higher and its PER lower than competitors, it may be undervalued.

4.3 EPS and Dividends

EPS also connects directly to dividend payouts. A company with strong, stable EPS is more likely to maintain or increase dividends, while companies with weak EPS may struggle to sustain payouts.

5. Real-World Examples of EPS and Stock Prices

Example 1: Global Tech Companies

Apple is a prime example of how rising EPS has driven long-term stock price growth. As EPS consistently increased, investor confidence and share prices followed.

Example 2: Biotech Failures

Some biotech firms experienced EPS collapses due to failed drug trials, causing stock prices to plunge in tandem.

Example 3: Energy Sector Divergence

Energy companies often see EPS surge during oil price booms, but stock prices may not fully reflect it due to concerns about volatility. This shows stock prices account for risk beyond EPS alone.

6. Limitations of EPS

Accounting Manipulation
- EPS is based on net income, which can be influenced by accounting choices or one-off items.
- Always check operating profit and cash flow alongside EPS.
Growth vs. Value Companies
- Growth stocks may have low EPS today but high valuations due to future expectations.
- Value stocks usually trade on stable or high EPS today.
Cyclical Risks
- EPS of industries like autos, steel, or energy can swing widely depending on the economic cycle.
- Long-term trend analysis is essential.

7. Key Takeaways for Investors

EPS is a fundamental link between corporate profitability and stock prices.
Over the long run, stock prices tend to follow EPS growth.
Different types of EPS (Basic, Diluted, Forward) should be evaluated together.
EPS growth rate, industry comparisons, and dividend policies provide deeper insights.
While short-term price moves may diverge from EPS, long-term trends align closely.

8. Conclusion

EPS is more than just a number—it’s a bridge connecting a company’s earnings power to its stock price. By understanding the relationship between EPS and stock prices, investors can avoid being swayed by short-term volatility and instead focus on long-term value creation.

In my own investing journey, I shifted from chasing price movements to analyzing EPS trends. This shift helped me view companies more systematically and make more rational investment decisions.