Earnings Per Share (EPS) Framework
Focus on ROE, not EPS
The EPS framework emphasizes the importance of focusing on return on equity (ROE) rather than earnings per share (EPS) when evaluating a company's performance. This is because EPS can be misleading, as it does not account for the amount of capital employed to generate earnings. In contrast, ROE provides a more accurate measure of a company's ability to generate profits from its equity capital.
- Focus on return on equity (ROE) rather than earnings per share (EPS)
- EPS can be misleading due to its failure to account for capital employed
- ROE provides a more accurate measure of a company's ability to generate profits from its equity capital
- Calculate ROECalculate the return on equity (ROE) by dividing net income by total shareholder equityPro tipUse a consistent methodology when calculating ROE to ensure comparability across different companies and time periodsWarningBe aware of the potential for accounting gimmickry that can distort ROE calculations
- Evaluate EPS in contextConsider EPS in the context of ROE and other financial metrics to gain a more comprehensive understanding of a company's performancePro tipUse EPS as a secondary metric to ROE, and be cautious of companies that prioritize EPS growth over ROEWarningBe aware of the potential for EPS to be manipulated through accounting practices or share buybacks
Berkshire Hathaway's ROE has consistently outperformed its EPS growth, demonstrating the importance of focusing on ROE when evaluating the company's performance
Warren Buffett has long advocated for focusing on ROE rather than EPS, as it provides a more comprehensive picture of a company's financial health. This framework is rooted in his value investing philosophy, which emphasizes the importance of evaluating a company's intrinsic value rather than its short-term stock price movements.