Capital Allocation Trends At Electronic Arts (NASDAQ:EA) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Electronic Arts (NASDAQ:EA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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)

0.097 = US$996m ÷ (US$14b - US$3.6b) (Based on the trailing twelve months to December 2021).

So, Electronic Arts has an ROCE of 9.7%. Even though it's in line with the industry average of 10%, it's still a low return by itself.

View 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, you can check out the forecasts from the analysts covering Electronic Arts here for free.

What Can We Tell From Electronic Arts' ROCE Trend?

In terms of Electronic Arts' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 22% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Electronic Arts has done well to pay down its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. 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.

The Key Takeaway

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. And the stock has followed suit returning a meaningful 45% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to continue researching Electronic Arts, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Electronic Arts isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.