Here's What's Concerning About Electronic Arts' (NASDAQ:EA) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Electronic Arts is:

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

0.15 = US$1.5b ÷ (US$13b - US$2.8b) (Based on the trailing twelve months to September 2023).

So, Electronic Arts has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 9.6% it's much better.

Check out 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.

What Does the ROCE Trend For Electronic Arts Tell Us?

The trend of ROCE doesn't look fantastic because it's fallen from 19% five years ago, while the business's capital employed increased by 52%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Electronic Arts' earnings and if they change as a result from the capital raise. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

Our Take On Electronic Arts' ROCE

Bringing it all together, while we're somewhat encouraged by Electronic Arts' reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 56% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know about the risks facing Electronic Arts, we've discovered 1 warning sign that you should be aware of.

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.

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.