There Are Reasons To Feel Uneasy About Electronic Arts' (NASDAQ:EA) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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?

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

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

0.13 = US$1.4b ÷ (US$13b - US$2.6b) (Based on the trailing twelve months to September 2022).

Therefore, Electronic Arts has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 8.4% 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, you can check out the forecasts from the analysts covering Electronic Arts here for free.

The Trend Of ROCE

On the surface, the trend of ROCE at Electronic Arts doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 13%. 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.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Electronic Arts is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 10% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

On a final note, we've found 1 warning sign for Electronic Arts that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.