5.4. Looking Only at Revenue or EPS
Lesson objective
Avoid allowing one metric to dominate.
Revenue may rise while margins and cash flow weaken. EPS may increase because of share repurchases or unusual items. FCF may decline because of temporary investment.
The solution is to read a coherent set of measures: growth, margins, profit, cash, balance-sheet strength, and shares outstanding.
Divergences are opportunities for investigation, not inconveniences to hide.
Simple example
In the event reviewed, MSFT showed higher Revenue and Net Income with lower FCF.
Revenue and EPS are endpoints of different chains
Revenue growth can be valuable, but only if enough of that growth survives costs and reinvestment. EPS can grow for reasons that do not imply stronger operations.
Follow both chains:
Revenue → Gross profit → Operating profit → Net income → EPS
and
Net income → Non-cash adjustments → Working capital → Operating cash flow → CapEx → Free cash flow
EPS also depends on share count
EPS = Net income available to common shareholders ÷ Weighted-average shares
A company can increase EPS by reducing shares even if net income barely grows. That may be beneficial, but it is different from operating growth.
Same EPS growth, different quality
Company A grows EPS 15% because revenue and operating profit rise with stable share count. Company B grows EPS 15% mostly because it repurchased many shares while operating profit stayed flat. The headline is identical; the economic story is not.
Whenever revenue or EPS looks unusually strong, check margins, share count, cash flow, and one-time items before deciding what the growth means.
What you should remember
- Look for relationships among the financial statements.
Practice
Find one divergence in a company's results and write two possible explanations.