EPS can be a helpful metric when evaluating company performance, but it does have certain limitations. Here are a few downsides of using EPS as the only statistic to measure a firm:
Easy to game: Individuals can manipulate EPS with creative accounting, mergers and acquisitions or share buybacks. None of these things are necessarily nefarious, but they can throw some EPS numbers into havoc. Remember, executives have strong incentives to show continuous EPS growth.
Exceptional expenses: Companies occasionally leave certain expenses out of EPS numbers if they’re “non-core.” This practice is known as adjusted EPS, which can be misleading if the costs left off are significant.
Inflation and debt: Rising inflation and unsustainable debt loads often create serious issues within firms. Unfortunately, neither inflation or debt factors into the EPS calculation. Diligent investors can only perform a comprehensive investment analysis with knowledge of inflation rates or debt levels.