How Did Electronic Arts Inc’s (EA) 28.55% ROE Fare Against The Industry?
Electronic Arts Inc (NASDAQ:EA) delivered an ROE of 28.55% over the past 12 months, which is an impressive feat relative to its industry average of 13.69% during the same period. Superficially, this looks great since we know that EA has generated big profits with little equity capital; however, ROE doesn’t tell us how much EA has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of EA’s ROE. View our latest analysis for Electronic Arts
Breaking down Return on Equity
Return on Equity (ROE) weighs EA’s profit against the level of its shareholders’ equity. For example, if EA invests $1 in the form of equity, it will generate $0.29 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of EA’s equity capital deployed. Its cost of equity is 9.73%. This means EA returns enough to cover its own cost of equity, with a buffer of 18.82%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient EA is with its cost management. Asset turnover reveals how much revenue can be generated from EA’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable EA’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt EA currently has. Currently the debt-to-equity ratio stands at a low 22.09%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? EA’s ROE is impressive relative to the industry average and also covers its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you're looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in EA, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Electronic Arts to help you make a more informed investment decision.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
