Electronic Arts (NASDAQ:EA) Will Want To Turn Around Its Return Trends

By
Simply Wall St
Published
November 26, 2021
NasdaqGS:EA
Source: Shutterstock

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Electronic Arts is:

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

0.11 = US$1.1b ÷ (US$13b - US$2.6b) (Based on the trailing twelve months to September 2021).

Thus, Electronic Arts has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 10% generated by the Entertainment industry.

Check out our latest analysis for Electronic Arts

roce
NasdaqGS:EA Return on Capital Employed November 27th 2021

In the above chart we have measured Electronic Arts' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

In terms of Electronic Arts' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 11%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Electronic Arts has done well to pay down its current liabilities to 20% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Electronic Arts. Furthermore the stock has climbed 67% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we've found 2 warning signs for Electronic Arts that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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