When analyzing earnings reports, two numbers dominate the headlines: earnings per share (EPS) and revenue. Investors debate endlessly about which metric matters more. The truth is that both are important, but their relative significance depends on the company's stage of growth, industry, and current market conditions.
Understanding Revenue (Top Line)
Revenue, also called sales or the top line, represents the total money a company earns from its business operations before any expenses are deducted. Revenue shows the size of the business and whether demand for its products or services is growing.
Revenue is calculated simply as price multiplied by quantity. If a company sells 1 million units at $100 each, its revenue is $100 million. Revenue growth indicates that a company is either selling more units, charging higher prices, or both.
Why Revenue Matters: Revenue is harder to manipulate than earnings. A company can boost short-term profits through cost cuts, accounting changes, or one-time items. But growing revenue requires actually selling more goods or services to customers.
Understanding EPS (Bottom Line)
Earnings per share represents the company's profit divided by the number of outstanding shares. EPS tells investors how much money the company earned for each share they own. The bottom line shows whether the company can convert revenue into actual profit.
EPS can be reported in different ways:
- Basic EPS: Net income divided by weighted average shares outstanding
- Diluted EPS: Accounts for potential shares from options and convertible securities
- GAAP EPS: Following standard accounting rules
- Adjusted EPS: Excluding one-time or non-cash items
Example: EPS Calculation
Company XYZ reports net income of $500 million with 100 million shares outstanding.
Basic EPS = $500 million / 100 million shares = $5.00 per share
If the stock trades at $100, the P/E ratio would be 20x earnings.
When Revenue Matters More
Growth Companies
For young, fast-growing companies, revenue growth is often the primary focus. These companies are typically investing heavily to capture market share, so profits may be minimal or negative. Investors accept lower near-term profits in exchange for rapid revenue expansion.
Example: Growth Company Focus
A cloud software company growing revenue at 40% per year might be losing money or barely profitable.
Investors prioritize revenue growth because they believe profits will come later as the company scales.
Amazon famously prioritized revenue growth over profits for nearly two decades before becoming highly profitable.
Market Share Battles
When companies compete for dominance in a new market, revenue growth indicates who is winning. The company capturing the most customers and revenue often emerges as the long-term winner, even if short-term profits suffer.
Subscription Businesses
For subscription and recurring revenue businesses, growing the customer base matters most. Each new subscriber provides years of future revenue, so adding customers (revenue growth) creates long-term value even at the expense of current profits.
When EPS Matters More
Mature Companies
For established companies with stable market positions, the focus shifts to profitability. Revenue growth may be modest, so investors want to see the company converting sales into increasing profits. Cost discipline and margin expansion become critical.
Example: Mature Company Focus
A consumer staples company like Procter & Gamble might grow revenue only 3-4% per year.
Investors focus on whether the company can improve margins and grow EPS faster than revenue through efficiency gains.
Share buybacks also boost EPS by reducing shares outstanding.
Cyclical Companies
For companies in cyclical industries like autos, industrials, or commodities, earnings matter most because revenue can be volatile. Strong earnings during good times build the cash reserves needed to survive downturns.
Value Investing
Value investors typically emphasize earnings and the price-to-earnings ratio. They seek companies trading at low P/E multiples with strong and stable earnings. Revenue growth is secondary to profitability and valuation.
The Interplay Between Revenue and EPS
Revenue and EPS do not move independently. Here are the key relationships:
Operating Leverage
Companies with high fixed costs see EPS grow faster than revenue when sales increase. This operating leverage works both ways - EPS can fall sharply when revenue declines.
Margin Expansion
When a company increases profit margins, EPS grows faster than revenue. This can come from pricing power, cost cuts, or economies of scale. Margin compression has the opposite effect.
Share Buybacks
Companies can boost EPS without growing revenue by repurchasing shares. This reduces the denominator in the EPS calculation. However, buyback-driven EPS growth is generally valued less than organic growth.
Quality of Earnings: Not all EPS growth is equal. EPS growth from revenue expansion is generally more valuable than growth from cost cuts, margin tricks, or buybacks. Sustainable EPS growth requires underlying revenue growth.
How the Market Weighs Each Metric
Stock price reactions to earnings reports reveal which metric the market cares about for each company:
Example: Market Reaction Analysis
Scenario 1: Growth tech company beats EPS but misses revenue by 2%
Result: Stock falls 8% because revenue growth disappointed
Scenario 2: Mature industrial company misses EPS but beats revenue
Result: Stock falls 5% because profitability disappointed
The market reaction tells you which metric matters more for that specific company.
Analyzing Both Together
Smart investors analyze revenue and EPS together rather than in isolation. Here is a framework:
- Revenue growth rate: Is the business expanding or contracting?
- EPS growth rate: Is profitability improving?
- Comparison: Is EPS growing faster than revenue (margin expansion) or slower (margin compression)?
- Quality: Is EPS growth driven by revenue, cost cuts, or financial engineering?
- Sustainability: Can current trends continue?
Warning: Watch for Red Flags
Be cautious when EPS grows while revenue declines. This is usually unsustainable and suggests the company is cutting its way to profitability rather than growing. Also watch for EPS beats driven primarily by lower tax rates or one-time gains.
Sector-Specific Considerations
- Technology: Revenue growth often matters most, especially for SaaS companies where recurring revenue has high long-term value
- Healthcare: Mixed focus - biotech emphasizes pipeline, while pharma emphasizes EPS
- Financials: EPS typically matters more, along with specific metrics like net interest margin
- Consumer: Both matter - revenue shows demand trends, EPS shows pricing power
- Energy: EPS matters most in this cyclical sector, along with cash flow
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Summary
The debate between EPS and revenue has no universal answer. Revenue matters more for growth companies fighting for market share, while EPS matters more for mature companies focused on profitability. The best analysis considers both metrics together, examining whether EPS growth is driven by genuine revenue expansion or financial engineering. Understanding which metric matters more for each stock you own helps you interpret earnings results and anticipate stock reactions.
Learn more: Earnings Report Basics and Earnings Beat or Miss.