How Companies increase EPS (Earnings Per Share)

How Companies Increase EPS (Earnings Per Share)

When it comes to investing, we want to look for companies that are consistently increasing their earnings per share (EPS).  An upward trend in the EPS leads to more consistent results for the shareholders.  A down trending EPS or sporadic EPS will usually lead to disappointing results in your investment.  When I am looking for solid performing companies that would be good candidates for my dividend growth stock portfolio, one of the first things I always look at is the EPS trend.  The next thing you want to determine if the EPS are rising year after year is how the company is achieving these results.  When it comes to earnings per share, there are generally only 2 ways that a company can increase them.

Increase Net Income

Companies that are annually increasing their net income are going to be successful.  Typically, along with an increased net income will come an increased EPS.  The only reason EPS would not increase while net income increases is if the company is diluting the outstanding shares by issuing new shares.  As an investor we want to stay away from these situations.  We prefer the situations where an increase in net income directly result in an increase in EPS.

Net income is simply Sales or Revenues of a company minus that companies Expenses.  The only ways a company can increase their net income is by either increasing sales or by decreasing their expenses.  As an investor I like seeing companies who can do both.  Keeping expenses within reason means management isn’t wasteful with my capital.  Increasing sales means management is doing a good job bringing in revenues to grow the company.

So while both increasing sales and decreasing expenses are a good thing, as an investor I prefer to see the increasing sales.  This is because I know customers want whatever it is my company has to offer.  The customers are willing to spend their money on the product or services my company offers.  Sales increase net income and there is usually no ceiling to how many sales a company can have.  If there are customers willing to buy from you, you can make more and more sales.  Expenses can be lowered and this will increase our net income.  But expenses can only be lowered so much.  So while there is a floor to how low a company can make their expenses, there is no ceiling to how high a company’s sales revenue can go.  This is why I prefer to see the increasing sales.

When it comes to an increasing EPS trend, I like to see that it is being driven by increasing net income which is also being driven by increasing sales revenues.

Less Shares Outstanding

Companies will also see increasing EPS if they are doing share buybacks.  Sometimes management will decide to use some of their profits to purchase some of their outstanding shares off the market and retire them.  You will notice a downward trend from year to year in the number of outstanding shares.  This is a good thing.  With fewer shares outstanding, each remaining share is now worth a greater proportion of the company.

If a company is keeping their net income even through the years but decreasing the number of shares outstanding I will still see an increase in my EPS.  When I am evaluating companies I like to check the number of shares outstanding to make sure it is either staying flat or decreasing.  The last thing I want to see is increasing shares outstanding because I then own a smaller portion of the company.


The bottom line is I like to see increasing EPS.  A company can do that by increasing net income, decreasing the shares outstanding or possibly both methods.  It is important to analyze the company to determine how they are increasing their EPS.  One thing you can be sure of is that if you buy in at the right price and a company is consistently growing their earnings per share, you will most likely enjoy a nice performance from your investment.

Stock Valuation – How To Value A Company

Stock Valuation – The Relationship Between A Company’s Stock Price and Cash

In another article titled Companies To Invest In, I made the point that, at its core, a well-run company is simply a money making machine.  That concept – that the value of a company is ultimately tied to cash – is one of the keys to understanding how to value a company and it’s relationship stock price.  Stock valuation are great to get quick snapshot of a company’s value.  I’ll illustrate this point with a simple example, and then build on it in ensuing articles.

How To Value A Company – Cash Per Share Example 1

If there were a company that had $1,000 in cash with 100 shares of stock outstanding then you could calculate the value of each share of stock as follows.

Stock Valuation Cash Per Share Example

How To Value A Company – Acquiring 20% Ownership Example 2

If that were the case and you wanted to own 20% of the company then how much stock would you have to buy, and how much would it cost?  The answer is that you would have to pay a total of $200 for 20 shares of stock, which can be calculated as follows.

Stock Valuation Ownership Example

How To Value A Company – 10:1 Stock Split Example 3

What if the company did a 10 for 1 stock split, meaning instead of having 100 shares outstanding, it had 1,000 shares outstanding?  Would that change the value of the company?  The answer is no.  The company’s only asset is $1,000 of cash, and no amount of stock splitting (or combining) can change that.  However, by doing a 10 for 1 stock split the value of each individual share is diluted, going from $10 to $1 per share.  So in summary, a stock split affects the value of each share of stock, not the value of the company itself, which can be illustrated as follows.

Stock Valuation Stock Split Example

Now, what if our little company went public and was traded on the New York Stock Exchange?  Wow, that’s big time!  Wouldn’t that would boost its stock price above the $1 it’s now trading at after the stock split?  Not at all!  The stock could be traded on the moon, and that still wouldn’t alter the fact that the total assets of the company are worth $1,000, making the value of each of those 1,000 shares equal to $1.

How To Value A Company Using The Terminal Valuation Method

But wait, isn’t just focusing on a company’s cash overly simplistic?  After all, there’s no company of any size or consequence whose only asset is cash.  While that may be true, at the end of the day, determining how to value a company is ultimately measured in money (or cash) – nothing else.  This is known as the terminal value of a company.

The application of this concept is known as the Terminal Valuation Method.  To illustrate how it works, say a company’s stock price is trading at a value that suggests the total worth of the company is $10,000,000.[1]  How can you tell if this stock valuation is reasonable?  One way to go about it is by to pretending that the company sold everything off: its inventory, furniture and fixtures, real property, and so on, until it converted all of its assets to cash.  After going through exercise you estimate that upon liquidating all of its assets and settling all of its outstanding debts (or “liabilities”) that the company would end up with $4,000,000.

“It’s Important To Note Stock Valuation Can Vary Greatly Depending On A Number Of Factors Such As: Industry, Maturity Level of Company, Ect.”

What…$4,000,000?  Didn’t we say that the value of the company’s stock suggested that it was worth $10,000,000?  Does this mean that the company’s stock price is vastly over inflated relative to its true worth? Perhaps, but not necessarily.  For example, aside from tangible assets (assets that you can touch) that could be converted into cash, an established company might have valuable intangible assets that would substantially contribute to its ability to make money: established business relationships, a highly skilled workforce, an efficient supply chain, secret formulas and patents, widely recognized brands and trademarks, etc.  In short, there can be a lot more to the value of a company than just its “hard assets” such as cash, inventory, property, etc.

However (and this is a BIG however), if a company is being valued at $10,000,000 and yet it would only be worth $4,000,000 upon liquidation, there still has to be a financial explanation for where that remaining $6,000,000 of value is coming from.  In other words, what is it about the company that makes it worth more than sum of its tangible assets?  If there is a compelling story there – a story that explains how the company’s business prospects, activities and operations are worth an extra $6,000,000 – then the stock valuation of the company can be justified.  If not then the company’s stock price is being pumped up by hype and hot air.


While it’s true that you cannot you cannot fully measure the value of a company based on its hard assets (cash, inventory, buildings, etc.), it’s also true that a company’s value is ultimately measured in dollars.  That means when it comes to a company’s stock valuation, cash is king!

[1] This would be the case if, for example, a company’s stock was trading at $50 a share and there were 200,000 total shares outstanding ($50 x 200,000 shares = $10,000,000).