What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Electronic Arts (NASDAQ:EA) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Electronic Arts:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$1.1b ÷ (US$13b - US$3.0b) (Based on the trailing twelve months to March 2021).
Therefore, Electronic Arts has an ROCE of 10%. In isolation, that's a pretty standard return but against the Entertainment industry average of 14%, it's not as good.
Check out our latest analysis for Electronic Arts
Above you can see how the current ROCE for Electronic Arts compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Electronic Arts.
What The Trend Of ROCE Can Tell Us
In terms of Electronic Arts' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 10% from 19% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Electronic Arts has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line
To conclude, we've found that Electronic Arts is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 81% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, Electronic Arts does come with some risks, and we've found 2 warning signs that 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.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
"Electronic" - Google News
August 01, 2021 at 03:23PM
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Electronic Arts (NASDAQ:EA) Will Be Hoping To Turn Its Returns On Capital Around - Yahoo Finance
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