Are Electronic Arts Inc.'s (NASDAQ:EA) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

44 charts that explain markets and the economy right now

editorial-team@simplywallst.com (Simply Wall St)

Sat, Feb 1, 2025, 4:00 AM 4 min read

With its stock down 19% over the past three months, it is easy to disregard Electronic Arts (NASDAQ:EA). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Electronic Arts' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Electronic Arts

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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$7.4b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.14.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Electronic Arts' Earnings Growth And 14% ROE

To begin with, Electronic Arts seems to have a respectable ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. For this reason, Electronic Arts' five year net income decline of 22% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

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 21% in the same 5-year period.

past-earnings-growth — NasdaqGS:EA Past Earnings Growth February 1st 2025

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. Has the market priced in the future outlook for EA? You can find out in our latest intrinsic value infographic research report.

Is Electronic Arts Efficiently Re-investing Its Profits?

Electronic Arts' low three-year median payout ratio of 22% (or a retention ratio of 78%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Additionally, Electronic Arts has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 9.1% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 28%, over the same period.

Conclusion

In total, it does look like Electronic Arts has some positive aspects to its business. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.