Be Wary Of Electronic Arts (NASDAQ:EA) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Electronic Arts (NASDAQ:EA), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Electronic Arts:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.15 = US$1.6b ÷ (US$13b - US$3.1b) (Based on the trailing twelve months to December 2022).

Thus, Electronic Arts has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 10% generated by the Entertainment industry.

See our latest analysis for Electronic Arts

In the above chart we have measured Electronic Arts' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Electronic Arts.

SWOT Analysis for Electronic Arts

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Electronic Arts doesn't inspire confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 15%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Electronic Arts has decreased its current liabilities to 23% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Electronic Arts' ROCE

While returns have fallen for Electronic Arts in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 4.2% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you're still interested in Electronic Arts it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Electronic Arts may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.