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Are Strong Financial Prospects The Force That Is Driving The Momentum In Electronic Arts Inc.'s NASDAQ:EA) Stock?

Simply Wall St


Most readers would already be aware that Electronic Arts' (NASDAQ:EA) stock increased significantly by 21% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Electronic Arts' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.


View 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:

25% = US$2.0b ÷ US$7.8b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.25 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Electronic Arts' Earnings Growth And 25% ROE

First thing first, we like that Electronic Arts has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 20% also doesn't go unnoticed by us. So, the substantial 23% net income growth seen by Electronic Arts over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Electronic Arts' reported growth was lower than the industry growth of 38% in the same period, which is not something we like to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Electronic Arts''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Electronic Arts Making Efficient Use Of Its Profits?

Electronic Arts doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Summary

Overall, we are quite pleased with Electronic Arts' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.