What Happens to Stock Prices if the EPS Increases?

Stock price changes are notoriously difficult to predict, but the earnings-per-share figure is a good starting point for gauging a company's prospects. If a firm's EPS rises and meets or even beats consensus forecasts, the firm's shares stand to rise. However, sophisticated investors can spot management manipulation of EPS through actions such as buybacks.

EPS Explained

Earnings per share, is a measure of how much a share of stock earned or lost during a time period. EPS is usually measured on a quarterly and annual basis. An investor can quickly calculate the return on investment of a stock by utilizing EPS. For example, if an investor spent $20 per share on a stock and the firm's EPS was $5 for the period, then the return is $5/$20, or 25 percent.

Ratio Calculation

EPS is straightforward to calculate. Quarterly or annual reports tell investors the company's net income and its number of shares outstanding. To calculate EPS, divide net income by the number of shares outstanding. For example, if a company recorded net income of $20 million for 2011 and it had 15 million shares in the market, then the firm's EPS would equal $1.33. Companies' EPS ratios often are posted on financial websites, along with other ratios.

Consensus vs. Actual

When EPS increases, the stock's price might or might not rise. Often, EPS is compared to consensus EPS forecasts. Investment research websites consider many analysts' forecasts to reach consensus EPS. In general, if a firm's actual EPS does not rise to the level predicted by consensus, the share price falls. Conversely, if actual EPS beats the consensus, the price rises. However, sometimes even when forecasts are achieved, the price can slide if the overall market declines.

Warning: Buybacks

The price of a share will not automatically rise or fall based on EPS gains. Buybacks occur when a company repurchases its own shares. EPS then rises because net income is being divided by fewer numbers of shares. But market reaction to buybacks is often mixed. Investors might worry that management is manipulating EPS to hit compensation incentives rather than investing the cash in productive assets that could drive long-term growth in share price.

About the Author

Kevin O'Flynn began writing in 2008 with a background in private equity. He has written for MilitarySpot.com and lived and worked in the United Kingdom and Japan. O'Flynn holds a Master of Business Administration from Case Western Reserve University.

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