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Do Its Financials Have Any Role To Play In Driving Electronic Arts Inc.'s (NASDAQ:EA) Stock Up Recently?

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Electronic Arts' (NASDAQ:EA) stock is up by a considerable 22% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Electronic Arts' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Electronic Arts

How Do You Calculate Return On Equity?

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:

10% = US$789m ÷ US$7.6b (Based on the trailing twelve months to March 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Electronic Arts' Earnings Growth And 10% ROE

At first glance, Electronic Arts seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 9.9%. Despite this, Electronic Arts' five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

We then compared Electronic Arts' net income growth with the industry and found that the average industry growth rate was 28% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is EA worth today? The intrinsic value infographic in our free research report helps visualize whether EA is currently mispriced by the market.

Is Electronic Arts Efficiently Re-investing Its Profits?

Electronic Arts' low three-year median payout ratio of 23%, (meaning the company retains77% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Only recently, Electronic Arts started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 8.6% over the next three years. The fact that the company's ROE is expected to rise to 24% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that Electronic Arts has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.