Is Electronic Arts the Perfect Stock?

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 (Nasdaq: ERTS  ) 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.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 4.0% Fail
  1-Year Revenue Growth > 12% (1.8%) Fail
Margins Gross Margin > 35% 58.2% Pass
  Net Margin > 15% (7.7%) Fail
Balance Sheet Debt to Equity < 50% 0.0% Pass
  Current Ratio > 1.3 1.52 Pass
Opportunities Return on Equity > 15% (10.4%) Fail
Valuation Normalized P/E < 20 NM NM
Dividends Current Yield > 2% 0.0% Fail
  5-Year Dividend Growth > 10% 0.0% Fail
       
  Total Score   3 out of 9

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful due to negative earnings. Total score = number of passes.

With just three points, Electronic Arts won't show up on your high-score stock list. The video game maker has struggled against a tough environment for years now, and big competition still looms from several corners.

If you just looked at the most recent quarter, you might think that times for video games had never been better. EA, Take-Two Interactive (Nasdaq: TTWO  ) , and Activision Blizzard (Nasdaq: ATVI  ) all beat expectations in their most recent quarterly reports.

The problem, though, is that a horrible couple of years has tempered those expectations. With huge double-digit drops in sales in 2009 and 2010, 2011 comps may look good, but both software companies like EA and game hardware makers like Microsoft (Nasdaq: MSFT  ) and Sony (NYSE: SNE  ) still have plenty of ground to recover.

But the company is answering the call of the changing industry. Last month, Electronic Arts announced that it would make it possible for gamers to download PC games directly from the company rather than going through stores. That's obviously bad news for retailers like GameStop (NYSE: GME  ) , but as free and low-cost game options via social networks and smartphones proliferate, premium-game makers have to get every penny they can.

With the IPO of Zynga coming soon, the video game industry is going through a big revolution. EA may emerge victorious, but until it does, it isn't going to look like the perfect stock.

Keep searching
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.

Click here to add Electronic Arts to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Activision Blizzard, Microsoft, GameStop, and Take-Two. Motley Fool newsletter services have recommended buying shares of Microsoft, Activision Blizzard, and Take-Two; writing covered calls on GameStop; creating a diagonal call position on Microsoft; and creating a synthetic long position on 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. As you've probably gathered, The Motley Fool has a disclosure policy.


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