The leaders in video games are experiencing tremendous momentum so far this year with people at home during the pandemic. The wave of new players that has formed sets up Electronic Arts (EA 0.04%) for a strong 2020, especially when the new console generation kicks off this holiday season.
Most importantly, investors don't have to pay a nosebleed price to own Electronic Arts' shares given its relatively modest valuation compared to peers. Here's why Electronic Arts is a good bet in the growing interactive entertainment industry.
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A fair valuation
Electronic Arts might be one of the better values among the industry leaders right now. It has a forward price-to-earnings ratio of 26 times the consensus earnings estimate for fiscal 2021. That is in line with Activision Blizzard (ATVI +0.00%) and much lower than Take-Two Interactive (TTWO 0.59%).
Electronic Arts also matches up well with its peers on the basis of price to free cash flow.
EA PE Ratio (Forward) data by YCharts.
Some investors might favor Activision over Electronic Arts for the dividend (EA doesn't pay one), in addition to Activision's greater presence in the growing mobile game market. Still, EA stock has nearly doubled over the last five years, and I believe more gains are in store.
I personally own shares of all the top gaming companies, because a rising tide should lift all boats. Market researcher Newzoo forecasts the video game industry to grow approximately 25% to $200 billion by 2023. That's around $40 billion of incremental spending on games that will surely find its way to popular franchises owned by Electronic Arts, such as Madden, FIFA, The Sims, Battlefield, licensed Star Wars games, the battle royale shooter Apex Legends, and other titles EA may release.
Games are social networks
Sheltering in place fueled significant growth in live services across EA's games last quarter. Live services revenue jumped 61% year over year to $1.1 billion, which includes in-game spending on extra content, subscriptions, and advertising.
This performance was driven by "tens of millions" of new and returning players across the EA network of games, as CEO Andrew Wilson explained on the fiscal first-quarter conference call in late July. While in the near term, management remains uncertain about how long these high engagement levels will continue, Wilson said EA's games are serving as social networks as players compete with others online through multiplayer game modes.
"Our EA SPORTS live services are acting as social networks for sports fans around the world, and the strength of those connections will grow as real sports seasons return," Wilson said. "Players in our communities for The Sims, Apex, Star Wars and more are building relationships through our games, and we expect them to be with us for a long time to come."
It's unlikely EA will continue to post huge advances in its live services business every quarter going forward, but it's clear Wilson expects some of these new players to stick around and contribute to EA's growth.
EA checks a lot of boxes
Electronic Arts is enjoying strong momentum, but it's still not firing on all cylinders. Its mobile game business has fallen stagnant over the last few years and could use a jump-start, but that's obviously not holding the company back.
It's impressive that Electronic Arts was able to deliver 30 new content updates for its console and PC titles during the recent quarter while employees were working from home. Most of EA's employees will continue working from home through the end of the calendar year. This is an important advantage in an environment like this when major Hollywood movies have been delayed and people will be looking for alternative sources of entertainment.
Another advantage EA has is cash. It ended the last quarter with $5.9 billion in cash and short-term investments and very little debt. Given that hefty war chest, rumors are flying that EA and Activision are the likely bidders for AT&T's (T +2.60%) Warner Bros. Games division, which has an estimated value approaching $4 billion.
Whether or not EA ends up with Warner Bros. Games, it has the cash to either initiate a dividend or make an acquisition that increases the value of the company, particularly within its mobile business.
With an attractive valuation relative to peers, plenty of cash on the balance sheet, and explosive momentum happening across its biggest franchises, EA is a promising video game stock to consider buying today.
