Has Electronic Arts Become the Perfect Stock?
byJul 9th 2012 9:57AM
Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Electronic Arts (NAS: EA) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Electronic Arts.
|Growth||5-Year Annual Revenue Growth > 15%||6.0%||Fail|
|1-Year Revenue Growth > 12%||15.4%||Pass|
|Margins||Gross Margin > 35%||61.7%||Pass|
|Net Margin > 15%||1.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||21.9%||Pass|
|Current Ratio > 1.3||1.23||Fail|
|Opportunities||Return on Equity > 15%||3.0%||Fail|
|Valuation||Normalized P/E < 20||113.37||Fail|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Electronic Arts last year, the company hasn't been able to improve on its three-point score. The company did manage to regain profitability, but the shares have lost half their value as the company faces a fundamental challenge to its long-successful business model.
For years, Electronic Arts and competitors Activision Blizzard (NAS: ATVI) and Take-Two Interactive (NAS: TTWO) had the video game market largely to themselves. By selling high-priced games for use on expensive game consoles, the industry capitalized on the willingness of gamers to pay up for an intense experience. That framework supported the entire business model of GameStop's (NYS: GME) game-resale niche.
Now, though, the rise of Zynga (NAS: ZNGA) and Internet-based casual gaming has put Electronic Arts and its peers to the test. Electronic Arts has experimented with selling some of its games in an iPad format, but with prices of $0.99 to $2.99, the revenue from those sales just can't compete with the $50 or more that console-based games fetch.
So far, Electronic Arts hasn't been able to respond well. With many subscribers choosing not to renew free trials of its Star Wars: The Old Republic release, which was seen as the company's best chance to go up against Activision's World of Warcraft, Electronic Arts just seems to be struggling without direction.
For Electronic Arts to recover, it needs to find a way to reawaken interest in higher-priced games. That's a tall order, but the company has the chops to come out with high-quality offerings worth a better price point. Unless it does so, it's hard to see how Electronic Arts will start looking more like a perfect stock.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
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At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of GameStop and Activision Blizzard and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Activision Blizzard and Take-Two, writing covered calls on GameStop, and creating a synthetic long position in Activision Blizzard. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.
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