Estimating The Intrinsic Value Of Electronic Arts Inc (NASDAQ:EA)
I am going to run you through how I calculated the intrinsic value of Electronic Arts Inc (NASDAQ:EA) by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.
Check out our latest analysis for Electronic Arts
The model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $1.39k | $1.59k | $1.69k | $1.91k | $2.10k |
Source | Analyst x10 | Analyst x12 | Analyst x8 | Analyst x4 | Analyst x4 |
Present Value Discounted @ 9.9% | $1.27k | $1.32k | $1.28k | $1.31k | $1.31k |
Present Value of 5-year Cash Flow (PVCF)= US$6.5b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 9.9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$2.1b × (1 + 2.9%) ÷ (9.9% – 2.9%) = US$31.1b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$31.1b ÷ ( 1 + 9.9%)5 = US$19.4b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$25.8b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $84.79. Relative to the current share price of $94.2, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Important assumptions
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Electronic Arts as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.9%, which is based on a levered beta of 0.986. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For EA, I’ve compiled three important aspects you should further examine:
Financial Health: Does EA have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does EA’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of EA? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
