The Story Behind Stock Prices: EPS, profit growth, and long-term investment returns

Investing in different types of assets can be complex, but understanding the basics can help. Below we explore how stock returns, earnings, and company growth are connected, and why earnings per share (EPS) is an important measure for investors to understand.

In the short term, day to day stock prices can be affected by many factors, and the old saying about why a stock went up on a given day can hold true;
 “Today there were just more buyers than sellers”.  

But over the long run, stock prices (and the returns from owning stocks) are typically driven by one primary factor, a company’s profits now and in the future, which ultimately motivates the buying and selling. In practice, when companies grow their profit consistently, they're likely to see their stock price rise, too.  

EPS is a simple metric investors use to try and understand this trend, and is simply calculated by dividing a company’s annual profit by its number of shares. A higher EPS means the company is more profitable and, all things otherwise equal, makes its stock more attractive to investors. EPS also helps compare how profitable different companies are within the same industry, helping investors decide if a stock is attractive or overpriced.

On a bigger (“macro”) scale, a company’s success is usually interlinked to some extent with the performance of the overall economy, typically measured by gross domestic product (GDP). When GDP is growing, businesses tend to do well because people and companies spend more, boosting revenues, and boosting profits. On the flip side, when GDP is down, it usually means the economy is sluggish, which can reduce consumer spending, reducing revenues and reducing profits. On a smaller (“micro”) scale, a company's growth shows how well it can expand its operations, increase sales, and capture a larger market share. 

Why has the US stock market come to represent such a large share of global markets?  While there are a few factors at play, we would highlight that over the past 10-15 years US companies have consistently demonstrated strong earnings performance, particularly when compared to other economies. This trend continued into the end of 2024, which was a stellar quarter for many US firms.

We can see from the chart below how US companies have had consistently higher EPS and EPS growth than European companies:

Source: FactSet, Data from 31/03/2010 to 17/03/2025

And as we can see over the long term, the total return of the US stock market has materially outpaced returns from companies in Europe, mirroring the EPS trend above. 

Source: FactSet, Data from 31/03/2010 to 17/03/2025

Despite challenges like changing trade policies and recession worries, US companies have remained strong in maintaining high EPS and EPS growth. In the absence of a big reversal in the US economy, we could expect strong US company earnings growth to continue over the course of 2025. And while there are many factors that may affect stock prices and market performance in the short term, as we can see from these charts, ultimately stock returns “follow the earnings”.

In terms of the investment case for exposure to the US market and international diversification, our confidence in long-term US equities remains strong, supported by consistent earnings growth, resilient consumer and business spending, and a favourable economic backdrop, despite short-term uncertainties.

The Noise

• The pound sterling climbed to $1.30 per £1 on Monday, for the first time since the US election in November 2024. This recent currency move can be largely attributed to investors’ concerns about economic damage and potential inflationary fallout from President Trump’s erratic policies. The pound has also been supported by investors betting that the UK is less exposed to tariffs than some other economies. The result being that people’s purchasing power against the dollar has marginally increased, getting more dollars per pound compared to the previous four months.

• The Bank of England (BoE) held interest rates at 4.5% at their March monetary policy meeting. The BoE Chair, Andrew Bailey, quoted economic uncertainty as the main driver for keeping rates steady. Looking ahead, The Bank of England faces a challenging task in the upcoming months, weighing signs of a stagnating economy in the UK, a slowing job market, and the possibility of rising inflation. Followingly, markets have priced in a 77% likelihood of an interest rate cut at the BoE’s next monetary policy meeting in May.

• The US Federal Reserve (Fed) kept its central interest rate at 4.5%, in line with market expectations at their March monetary policy meeting. The Fed had previously been on a ‘rate cutting cycle’ in January, which incrementally lowered cost of borrowing in America. Yet with an uncertain economic outlook, following President Trump’s erratic trade policy implementation, they have held interest rates steady as such policies have been forecast to be inflationary in nature. This said, the market still expects at least two rate cuts this year, with traders betting a 62% chance that the Fed resuming its rate cuts at its June monetary policy meeting.

The Numbers

GBP Performance to 20/03/2025

Source: Bloomberg, data as at 20/03/2025