Why EPS Misleads Investors and Why Return on Net Worth Tells the Real Story

When new investors enter the stock market, one of the first financial metrics they hear about is Earnings Per Share (EPS). It sounds simple and even logical. If a company earns ₹100 crore in profit and has 10 crore shares, then EPS = ₹10. The quick next step in thinking is: “If average companies trade at 15 times earnings, this stock should be worth ₹150.”

At first glance, this approach seems like a neat formula for stock valuation. However, this is only half the story. EPS tells you the absolute profit per share but ignores how efficiently a company generates that profit from the capital invested in the business. That’s where Return on Net Worth (RoNW), also called Return on Equity (ROE), becomes the true yardstick of business quality.

Why EPS Alone Can Be Misleading

EPS is often treated as the holy grail for beginners because it is easy to calculate. But in isolation, it can be dangerously misleading.

Let’s take an example.

  • Company A raises ₹1 crore and generates a profit of ₹10 lakh. Its RoNW is 10%.
  • Company B raises ₹2 crore and generates a profit of ₹20 lakh. Its EPS may look higher depending on share count, but its RoNW is still 10%.

On paper, Company B looks “better” because of higher profits and EPS. But in reality, both are equally efficient in generating returns on shareholder capital.

This highlights the core problem: EPS reflects size, not efficiency. Investors who blindly multiply EPS with a P/E ratio risk falling into traps where companies show big earnings but fail to create lasting wealth.

Case Study 1: HDFC Bank vs. State Bank of India (2005–2020)

A classic example of why RoNW matters more than EPS comes from comparing HDFC Bank with State Bank of India (SBI).

Snapshot Numbers

HDFC Bank – the consistent compounder

  • RoNW (2005–2020): 16–18% (stable and reliable)
  • Average P/E: 25–35
  • EPS Growth (CAGR 2005–2020): ~20%
  • Asset Quality: Gross NPA consistently below 2%

State Bank of India – the giant with inefficiencies

  • RoNW (2005–2020): 8–12%
  • Average P/E: 8–12
  • EPS Growth (CAGR 2005–2020): ~6%
  • Asset Quality: GNPA often spiking to 8–10%

Investor Outcome

  • ₹1 lakh invested in HDFC Bank in 2005 grew to nearly ₹25 lakh by 2020 (25x wealth in 15 years).
  • ₹1 lakh invested in SBI over the same period grew to only about ₹2.5–3 lakh.

Why the Difference?

SBI occasionally reported higher absolute profits and attractive EPS figures, but its RoNW was inconsistent. Poor asset quality, loan write-offs, and weak capital allocation ate into long-term returns.

HDFC Bank, though smaller, consistently generated high RoNW, proving it could turn every rupee of equity into sustainable profit. This consistency earned it higher valuations, and compounding worked in its favor.

Lesson: Investors who chased SBI’s EPS ended up disappointed, while those who looked at HDFC Bank’s RoNW reaped massive rewards.

Case Study 2: Infosys vs. Reliance Communications (2005–2015)

The telecom and IT sector comparison of the 2000s offers another powerful lesson.

Infosys – the efficient wealth creator

  • RoNW (2005–2015): 25–30%
  • EPS Growth CAGR: ~22%
  • Net Debt: Virtually zero
  • Wealth Creation: Stock price increased 6x in the decade

Reliance Communications – the low RoNW trap

  • RoNW (2005–2010): Already slipping to 8–10%
  • EPS Growth: Flat and erratic due to heavy debt
  • Net Debt: Exploded from ₹6,000 crore in 2005 to ₹40,000+ crore by 2015
  • Wealth Destruction: Stock price fell over 95%

Why Investors Got Misled

In 2007–08, Reliance Communications reported an EPS of ₹13–15, making it look “cheap” at a P/E of 15 compared to Infosys with an EPS of ₹60–70. Many retail investors thought it was a bargain.

But Infosys was delivering consistently high RoNW, while RCom was bleeding capital, piling on debt, and losing efficiency.

Result: Infosys compounded wealth, while RCom destroyed it—even though its EPS looked attractive at one point.

Case Study 3: Asian Paints vs. Hindustan Motors

The paints versus automobiles comparison highlights why sustainable RoNW matters far more than occasional EPS spikes.

Asian Paints – the efficient wealth creator

  • RoNW (10-year average): 23–28%
  • RoNW (2023–24): 19.51%
  • EPS (TTM): ₹55.65
  • 5-Year Stock Return: >300%
  • Wealth Creation (2010–2025): ₹1 lakh became over ₹12 lakh
  • Business Growth: Consistent, steady compounding driven by strong brand and distribution

Hindustan Motors – the illusion of profits

  • RoNW (prior decade): –5% to 5%
  • RoNW (2023–24): Spiked to 62–275%*
  • EPS (TTM): ₹0.56
  • 5-Year Stock Return: ~302%
  • Wealth Creation (2010–2025): Despite EPS spikes, negligible long-term wealth creation
  • Business Growth: Erratic and declining due to outdated technology and poor reinvestment

*The recent RoNW surge came from one-off asset sales and exceptional non-operational gains, not from core operations

Why Investors Got Misled

At first glance, Hindustan Motors appeared attractive because of sudden spikes in RoNW and short-term EPS growth. However, these gains were not generated from business efficiency—they came from selling assets. In contrast, Asian Paints consistently reinvested profits at high RoNW, delivering long-term compounding.

Result: Asian Paints became a wealth creator by sustaining efficiency, while Hindustan Motors destroyed long-term shareholder value despite short-term EPS illusions.

Practical Lessons for Investors

  1. EPS growth without RoNW is meaningless. If profits rise only because more capital is pumped in, shareholder value is not created.
  2. High RoNW indicates a strong moat and efficient management. It shows the business can reinvest at high returns, compounding over time.
  3. Don’t be blinded by absolute EPS. A company with ₹5 EPS and 25% RoNW can be far superior to a company with ₹20 EPS and 8% RoNW.
  4. Markets reward efficiency. Businesses like HDFC Bank, Infosys, and Asian Paints that consistently deliver high RoNW create real wealth.

Final Thought

The next time you analyze a stock, avoid the trap of thinking:
“EPS is 20, so at 15x P/E, the stock must be worth 300.”

Instead, ask:

  • What is the company’s RoNW?
  • Is it consistent over many years, not just one or two?
  • Can management reinvest profits at high returns on equity?

History has proven that RoNW is the compass for identifying long-term wealth creators, while EPS alone often leads to value traps.

Smart investors don’t just buy earnings—they buy efficiency, sustainability, and compounding power. That’s why companies like HDFC Bank, Infosys, and Asian Paints became legends, while SBI, RCom, and Hindustan Motors struggled despite size or temporary EPS spikes.

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