馃ぁ THE EARNINGS PER SHARE TRAP 馃ぁ
When someone asks what the performance of stocks depends on, the accepted answer is their financial reporting. Specifically, the EPS are mentioned as the main cause. EPS is a great metric because it implies net income and shares outstanding. Therefore, the consensus has been indoctrinated that if EPS grows, so does share price and profitability. But .... is this true?
It is easy to measure the returns because the prices are always positives. The complicated is to measure the EPS growth because they sometimes are negatives; due to this, it was taken the slope (beta) between annual EPS 2018 and annual EPS Q2 2023 LTM. If the thesis is true, yields should be directly proportional to their slope in at least >50%.
Based on a sample of 25 most popular stocks, the chart shows that the correlation between EPS Beta and the returns from 2018 to August 2023 is ≈ 3.5%. This means that the EPS explains in ≈ 0.12% the returns behaviour. The estimation error is so big. In effect, the calculation was based on thinking long term (as the establishment says you have to think because you have a better chance of winning).
A priori, some conclusions can be drawn:
- Taking EPS as a cause is a fallacy because it can be easily manipulated by Banks and Institutions through PER and their revisions.
- If the slope of prices is taken, correlation improves to ≈ 41% and causality by ≈ 17%. But who cares about the slope of a price? Whatever, there is ≈ 83% not explained by EPS.
- If the extreme value is taken out, the correlation does not improve; it is only ≈ 4%.
- The worst is the EPS slope, which is almost horizontal, with no improvement in average profitability.
Of course, this is only an example and overall results may vary depending on methodology and time frame. However, there are better financial elements that explain the correlation. I will publish a future post on this if you like this.
The list of stocks are:
- Nvidia
- AMD
- Tesla
- Apple
- Microsoft
- SolarEdge
- Monster Beverage
- Costco
- Visa
- American Express
- Enphase
- Meta
- Alphabet
- McKesson
- Northrop Grumman
- Boeing
- PayPal
- Pfizer
- Chevron
- Copart
- Nucor
- General Electric
- United Airlines
- Disney
- Darling Ingredients
The best analysis is yours!
J. Joel Padilla
Copyright: Joel Padilla 2023
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