Yahoo Finance Electronic Arts Inc.'s (NASDAQ:EA) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?
Electronic Arts' (NASDAQ:EA) stock is up by 8.1% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Electronic Arts' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Electronic Arts
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Electronic Arts is:
14% = US$1.0b ÷ US$7.6b (Based on the trailing twelve months to December 2022).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.14 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Electronic Arts' Earnings Growth And 14% ROE
At first glance, Electronic Arts seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. However, while Electronic Arts has a pretty respectable ROE, its five year net income decline rate was 9.0% . We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
That being said, we compared Electronic Arts' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 17% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is EA worth today? The intrinsic value infographic in our free research report helps visualize whether EA is currently mispriced by the market.
Is Electronic Arts Efficiently Re-investing Its Profits?
Electronic Arts' low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
Only recently, Electronic Arts stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 10% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 26%, over the same period.
Conclusion
Overall, we feel that Electronic Arts certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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