Before diving into what is earnings per share growth, one has to understand what is earnings per share. The earnings per share can be calculated by the formula shown below:
Earnings divided by number of shares outstanding
The earnings per share is an important metric as it allows investors, analysts and traders to calculate the value of the company.
Now that you understand this, earnings per share growth is simply the growth in earnings per share of a company that has been reported between 2 periods.
Company A has just reported an earnings per share of $3 for its latest fiscal year. In its industry, the fair price to earnings multiple is 10 times to 12 times. Applying a multiple of 10 times of $3, the company is worth $30. Currently the company is trading at $21. In such an instance, the company is undervalued. Investors and traders may consider buying the shares of the company with the projection that the share price of company A will increase over time.
Earnings per share growth
Earnings per share growth is a major driver of share prices. If earnings per share growth is reasonable and if the actual results manage to beat the estimates of analysts’ expectations, the share price will increase over the period of earnings per share growth.
An example as I will show here is Amazon, which experience and tremendous earnings per share growth from the fiscal year of 2015 to 2017 as shown below. As a result, share prices increased drastically from 2015 to 2017 as seen in the chart below.
Higher Multiples For Growth Stocks
It is a well known phenomenon that stocks which experience earnings per share growth tend to be rewarded by the markets with a higher Price to Earnings ratio multiple. For example a stock experiencing earnings per share growth could in year 0 be valued at a price to earnings ratio of 12 times and after reporting improved earnings, could be valued at a price to earnings ratio of 15 times.
Read: EBITDA(operating cashflow)