In this article, let's take a look at Electronic Arts Inc. (EA, Financial), a $13.56 billion market cap company that produces entertainment software for PCs, home video game consoles, mobile gaming devices, smartphones and tablets.
Great position
The company is the world's second-largest video game publisher. It has gained this position due to its video game franchises, for example, the sports game. The firm has a growth strategy that should bolster its competitive position. Also, it focuses on a smaller list of games.
With a renewed FIFA and Battlefield and new games for the new PlayStation 4 and Xbox One, it will continue holding its market position. Moreover, the company focuses on mobile and online games, which are high-margin products. Finally, the strategy of offering free download games should generate other purchases.
Acquisitions
Several acquisitions were made to consolidate the portfolio as well as the development of games with higher operating margins. Some years ago, it acquired BioWare Corp. and Pandemic Studios.
Major risks
The casual entertainment constitutes a major risk, and it has low barriers to entry. The growth of online gaming can create a great competition in the future because smaller competitors can reach consumers. So expanding its presence in online games will provide higher growth opportunities.
Revenues, margins and profitability
Looking at profitability, revenues grew by 42.44% and led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.01 vs -$0.89).
The net income growth from the same quarter one year ago has significantly exceeded the industry median. The net income increased by 101.1% when compared to the same quarter one year prior, from -$273.00 million to $3.00 million.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| EA | Electronic Arts | 16.41 |
| GAME | Shanda Games Ltd | 86.90 |
| ZNGA | Zynga Inc | -10.69 |
| KNM | Konami Corp | 2.26 |
| Â | Industry Median | 7.10 |
The company has a current ROE of 16.41% which is higher than the one exhibit by Zynga (ZNGA, Financial), Konami (KNM, Financial) and the industry median. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Shanda Games (GAME, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 38.9x, trading at a discount compared to an average of 54.3x for the industry. To use another metric, its price-to-book ratio of 5.09x indicates a premium versus the industry average of 3.33x while the price-to-sales ratio of 3.42x is above the industry average of 2.68x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $22,836, which represents a18% compound annual growth rate (CAGR).
Final comment
As outlined in the article, growing new markets such as online and mobile gaming should lead to revenue growth.
The PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.
Hedge fund gurus like Ray Dalio (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio) and Manning & Napier Advisors, Inc. added this stock to their portfolios in the third quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
