EA is up 10% so far this year - could it keep going?

January 30, 2019

EA is up 10% so far this year – could it keep going?

At the end of last year, the technology sector was one of the hardest hit areas of the stock market. Most of the best-known names in the sector dropped 20% or more before the end of 2018. Two of the segments of the tech sector that were the hardest hit were Semiconductors and Software companies, many of whom saw declines of 30%, 40%, or more. Just as these stocks outpaced the market to the downside then, at this early stage of the new year many of those same names are outpacing the broad market to the upside – and that could mean there are some interesting opportunities to be had at much more reasonable prices than just a few months ago.

Within the software segment, there is another sub-industry that has seen its share of volatility, and that is software gaming. This is a segment that I think the market has always treated as being highly cyclical and sensitive to broad economic pressures. That makes sense up to a point, since video games and gaming consoles have historically proven to be something of a luxury item, where sales growth is easier to achieve when economic activity like job creation and wages are increasing. I’m starting to think, however that a generational shift could make this segment less sensitive than it has been – and that means that this is a market segment that could continue to perform well even if the broader economy does actually begin to slow down.

Gaming has been around for a long time, of course, so the generational shift I’m talking about isn’t necessarily to suggest that there are going to be more gamers than their have been; in fact, there are a number of industry metrics that indicate total users could be leveling off or, in some cases even declining. The shift I think is occurring comes in the way gaming is treated as a regular activity in households.

I’ll use my family as an example. I grew up in the early decades of video games; I can remember when Pong was a big deal, and I blew major chunks of my allowance and lawn-mowing money at the arcade on Space Invaders, Pac-Man, and about a dozen other games from that age. Gaming consoles like Atari and Nintendo quickly found a place in my home, and I was as enthusiastic about my video games as anybody. When I started my own family, I still played video games, but the demands of providing for my family, along with the other demands of life meant that gaming became nothing more than an occasional diversion for me.

For my sons, however, gaming is a completely different story. Now in college, and working to build their own careers and lives, it’s been interesting to see how they make time to include gaming in their daily lives. Where my wife and I budget for things like dinner and a movie date nights, they budget for monthly subscriptions to their favorite games and gaming platforms, including paid updates. My sons represent the demographic that gaming companies like Activision Blizzard (ATVI), Take Two Interactive (TTWO) and Electronic Arts (EA) have been focusing their attention on for years; instead of simply trying to produce another cool game each year to generate a new batch of sales, these companies have transformed their development activities and business models to emphasize a continuous relationship with their customers, with revenue opportunities from monthly subscriptions that provide automatic updates and early release access to in-game purchase options for modules that provide specific, specialized gaming functions and features. 

My boys eat those things up, and they aren’t the only ones; it’s something that I’ve noticed really appeals to the Millennial generation. I think that means that gaming is becoming more and more a fundamental part of the economic landscape, because even if the economy does turn bearish, Millennials are going to find ways to make allowances for their games in their regular budgets. It means that while they may not become the same kind of defensive profile that I would put utilities or food and beverage companies into, I think that when the market does finally turn bearish, and even when the economy turns recessionary, gaming companies will maintain their fundamental strength far better than many analysts and experts think.

EA is one of the leading stocks in the gaming industry. If you’re familiar with gaming brands like FIFA, Madden NFL, Star Wars, Battlefield, the Sims, or even Plants vs. Zombies, then you’re familiar with this company’s work. The stock hit an all-time high in mid-July at nearly $152 per share, but dropped more than 51% until the latter part of December. From that point, however it has rallied more than 18% higher and looks like it could be setting up the beginning of new upward trend. With an overall strong fundamental profile, and an interesting value proposition, I think this could be a stock that really bears paying attention to.

Fundamental and Value Profile

Electronic Arts Inc. develops, markets, publishes and distributes games, content and services that can be played by consumers on a range of platforms, which include consoles, personal computers (PCs), mobile phones and tablets. The Company’s games and services are based on a portfolio of intellectual property that includes established brands, such as FIFA, Madden NFL, Star Wars, Battlefield, the Sims and Need for Speed. The Company markets and sells its games and services through retail channels and through digital distribution channels. The Company’s PC games and additional content can be downloaded directly through its Origin online platform, as well as through third-party online download stores. Its mobile, tablet and PC free-to-download games and additional content are available through third-party application storefronts, such as the Apple Application Store and Google Play. EA’s current market cap is $26.4 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings  increased 60%, while sales increased more than 34%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long term; however it is also a positive mark of management’s ability to maximize their business operation. In the last quarter, earnings grew more than 1,000% while sales increased a little more than 13%. The company also operates with an impressive margin profile, since Net Income has run consistently at around 19% for the past twelve months as well as the last quarter.
  • Free Cash Flow: EA’s free cash flow is healthy, if not remarkable, at a little over $1.3 billion. That translates to a Free Cash Flow Yield of about 5%.
  • Debt to Equity: EA has no long-term debt to speak of. Their balance sheet also shows more than $4.5 billion in cash and liquid assets in the last quarter. This number has declined since the beginning of 2018, when it was around $4.9 billion, but nonetheless is quite impressive and gives the company a lot of financial flexibility.
  • Dividend: EA, like most gaming stocks does not pay a dividend.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for EA is $17.44. That translates to a Price/Book ratio of 5.0 at the stock’s current price. Their historical average Price/Book ratio is 6.35, which means the stock is currently running at a discount of about 27% below the stock’s current price. That puts the stock’s long-term price target at around $110 per share, which is quite attractive but still significantly below the all-time high price it reached in July of last year.

Technical Profile

Here’s a look at the stock’s latest technical chart.

  • Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s downward trend from July to the end of December 2018; it also serves as the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s rally since late December appears to have hit a peak at around $92 per share; the pivot high from that point could mark the first step in new ABC stair-step pattern that could offer a legitimate new upward trend provided the stock finds support, and then pushes above that pivot high at $92. It appears to have some immediate support in the $85 price area, but a break below that point could easily see the stock retest its trend low at around $74 per share.
  • Near-term Keys: The stock’s current price activity isn’t offering a specific short-term trading signal; however a break above $92 should be taken as a good bullish signal to buy the stock, or work with call options with a near-term target price near to the $103 marked by the 38.2% retracement line. A break below $85 could offer an opportunity to short the stock, or to buy put options with an eye on the $74 to $75 level as a closing point for a bearish momentum trade. From a value-based standpoint, the stock looks like a very good value right now, with strong long-term upside.