Electronic Arts Inc. Stock Could Level Up

Bret Kenwell

Updated Tue, Apr 10, 2018, 6:30 PM

Longer term, video game stocks have been on the rise, with Electronic Arts Inc. (NASDAQ:EA), Activision Blizzard, Inc. (NASDAQ:ATVI) and Take-Two Interactive Software, Inc (NASDAQ:TTWO) all hitting 52-weeks in 2018. However, shorter term, ATVI, TTWO and EA stock have been under pressure.

Should investors lock in profits or use the recent selling opportunity to buy more shares?

The video game industry isn’t cheap by any standards. All three stocks trade with an elevated price-to-earnings (P/E) ratio. That gives many investors the impression that they are highly overvalued. However, thanks to their strong brands, dependable income streams and solid cash flow, the valuations can be somewhat deceiving.

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3 Positives for the Video Game Industry

There are a few other developments working in the gamemakers’ favor.

For starters, a healthy economy is a great tailwind to have at their backs. A strong economy encourages consumers to spend and makes them feel that tomorrow will be better than today. As a result, they may feel fine with picking up a copy of Madden or NBA 2K for themselves or their kid.

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Further, recent data from Nvidia Corporation (NASDAQ:NVDA) shows us that as younger people grow up, they aren’t giving up their games. Instead, many are sticking with one of their favorite past times. That boosts the average age of today’s gamers (source on page 42), which is understandably better for game-makers.

Finally, video game companies are a huge beneficiary of digitalization.

As online game stores become more popular, there’s less dependency on physical disks as gamers are able to download their favorite titles. Direct-to-consumer sales are good for video game makers, but micro-transactions are even better. Micro-transactions allow a company like EA to offer in-game purchases — something like unique jerseys, characters or weapon skins — for a few dollars. They can also develop new levels or maps and sell them in packs to players. It’s a relatively seamless transaction and while the price tag is often low, it’s high-margin add-on that directly boosts the top and bottom line.

Valuing Electronic Arts

Analysts aren’t looking for a crazy year of growth from Electronic Arts. Will that hurt EA stock after a robust year where shares rallied 34% over the past 12 months? It might keep shares compressed while the valuation works into a more a favorable level — even if that means shares consolidate for a few quarters.

So what do these growth numbers look like? Consensus estimates call for 4.4% sales growth this year and 8.8% growth next year. On the earnings front, forecasts are calling for 8.7% growth in 2018 and 17% growth in 2019.

While higher sales growth would have been better, it’s good to see such strong earnings growth. As earnings growth outpaces revenue growth, it shows that margins should improve this year and in 2019 as well. For this growth though, we’re paying 28 times 2018 earnings and about 23.8 times 2019 estimates.

When you can buy a company like Visa Inc (NYSE:V), Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) or Apple Inc. (NASDAQ:AAPL) for better growth and a lower valuation though, it makes one wonder whether EA stock is worth the price.

Trading EA Stock

The valuation is only so-so, but what do the charts say? A pretty solid trade setup is occurring in ATVI stock and one might be occurring in EA stock as well.

When looking at the above EA stock chart, the overall trend is pretty obvious. Shares have more or less adhered to our trend line (in black) for the better part of two years. It would be much more bullish if EA stock would stay above the $120 mark (purple line). EA has previously struggled to eclipse and stay above this mark — but today EA closed at $120.71. So we’ll see if it can hold on.

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On the plus side though, EA stock is above its 200-day moving average and its long-term trend-line. Bullish investors who want to take a long position in EA stock can do so, so long as the as those two observations remain true. Below trend-line support and a retest of the $100 to $105 level is back in play.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell held a position in GOOGL, AAPL, NVDA and V.