ANKARA, TURKEY – SEPTEMBER 12: A photo shows the logo of ‘Electronic Arts’ video game company on a … [+]
After a 60% rally off the March bottom, Electronic Arts stock (NASDAQ:EA) looks fully valued based on its historic P/E multiples. Electronic Arts’ stock has rallied from $95 to $135 off the recent bottom in-line with the S&P which moved around 41%, with resumption of economic activities as lock downs are gradually lifted. On the way down though, Electronic Arts outperformed with its stock down 14% between February 19 and March 23, compared to a 34% plunge for the S&P500. Electronic Arts stock is also up 33% from levels seen in March 2019, a little over a year ago.
Electronic Arts stock has not only fully recovered the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic, it is now up 23% from the levels seen during the pre-crisis peak in mid-February. This seems to make it fully valued, despite the higher demand for gaming seen over the recent months.
Some of the rise over the last year or so is justified by the roughly 12% y-o-y growth seen in Electronic Arts’ revenues in fiscal 2020 (fiscal year ends in March). Though the company’s net income margin contracted slightly from 27% to 26%, a 3% reduction in shares outstanding, clubbed with higher revenues, resulted in y-o-y adjusted EPS growth of 10%. With the steady revenue and earnings growth the company’s PE multiple has also expanded. We believe the stock is unlikely to see any significant upside despite the recent rally and the potential weakness from a recession driven by the Covid outbreak. Our dashboard, ‘What Factors Drove 33% Change in Electronic Arts Stock between 2017 and now?‘, has the underlying numbers.
Electronic Arts’ PE multiple changed from 23x in March 2019 to 21x in March 2020. While the company ‘s PE (trailing adjusted earnings) is now 28x, we believe that there is not much room for growth, when the current PE is compared to levels seen in the recent past: PE of 23x at the end of March 2019 and 21x as recent as March 2020.
Can EA stock can hold on to its gains?
The global spread of coronavirus has meant lockdowns in various cities, and increased restrictions on the movement of people. This is positive for companies, such as Electronic Arts, due to increased demand for gaming, given that more people are confined to their homes, eschewing more public forms of entertainment. That said, the rally across industries over recent weeks can primarily be attributed to the Fed stimulus which helped reduce investor concerns about the near-term survival of companies. The gradual lifting of lockdowns globally has also helped the demand for some non-essential goods recover, and this will likely weigh on the demand for gaming as well. But Electronic Arts’ stock beyond Covid-19, has more to look forward to. Over the next few years we expect continued growth in the company’s revenues and earnings, led by increased demand for games after the expected launch of newer generation consoles in the 2020 holiday season.
However, much of these factors are likely already priced in the company’s current stock price. While Electronic Arts’ Q1 fiscal 2021 results will be strong, investors will focus their attention on fiscal 2021 results and beyond – helping Electronic Arts stock to hold the gains it has seen over the recent weeks, but a further rally in the stock will depend on trends in gaming demand. At the current price of $135, Electronic Arts is trading at 27x its average consensus forward earnings, and the valuation appears to be in line with its closest peer – Activision Blizzard – which currently trades at 28x forward average consensus earnings.
While Electronic Arts stock looks like it is fully valued, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.