To get a good sense of a company's performance, investors can look at earnings per share. EPS is net income divided by the number of shares outstanding, and it is one piece of data investors cannot overlook.
Earnings and the factors that go into the bottom line are declared every quarter. While this is useful information, what is more useful is the track record of the company's earnings performance.
Studies of the most successful stocks found that the single most important characteristic is explosive earnings growth in the most recent quarter or two before the major price advances.
"If you look down a list of the market's biggest winners year in and year out, you'll instantly see the relationship between booming profits and booming stocks," IBD founder William O'Neil wrote in "How to Make Money in Stocks."
IBD's Proprietary EPS Rating
The IBD EPS Rating is a handy tool that tracks the earnings over the past three years and lets you know how a company compares with its peers and the rest of the market.
There are two key questions that the IBD EPS Rating answers: Has the company reported an increase in EPS from the previous year? Has the company reported stronger EPS numbers in the two most recent quarters?
If the company has increased its EPS by 25% from the previous year and has reported stronger results in the two most recent quarters, it gets a high IBD EPS Rating. Profits should increase at least that much in any stock you consider. The EPS Rating scale goes from 1 to a best-possible 99. Any rating above 80 indicates a strong record of earnings growth.
The EPS Rating compares a company's earnings with thousands of companies in the IBD database. A rating of 90 means that the company has been reporting earnings that are in the top 10% of earnings reported by all companies.
There are several ways in which a company improves its EPS. High growth companies with strong execution frequently report higher EPS. A company may also be able to increase its margins or reduce operating costs.
Other Ratings Count, Too
You can check the EPS Rating of a company on stock quotes at Investors.com and the IBD Stock checkup.
But it is also important to check other ratings such as a stock's Relative Strength Rating, Composite Rating and Accumulation/Distribution Rating. According to O'Neil, "the vast majority of superior stocks will rank 80 or higher on both the EPS and the RS ratings before their major moves."
The EPS Rating is not a definitive pointer to a company's future growth. An early stage company that has a low EPS Rating may become highly successful in later years. A company with a strong EPS Rating may face a losing streak due to challenging market conditions.
O'Neil believed the size of a company does not guarantee "innovation, growth, or profitability." Those qualities are best reflected in the growth rate of earnings. The EPS Rating, along with other IBD Ratings, is a much more accurate tool to gauge performance than the size of a company.
This article was originally published Aug. 5, 2022, and has been updated.
