Electronic Arts (EA -0.02%) has delivered stellar returns to investors over the last decade, and management is confident that more good times are ahead. To show its vote of confidence in the future, EA recently initiated its first ever quarterly dividend.
Here's why this top video game company is on its way to becoming a great dividend stock.
A cash powerhouse
During its fiscal second-quarter earnings report, EA declared a quarterly cash dividend payment of $0.17 per share, which will be payable on Dec. 23 to shareholders as of the close of business on Dec. 2.
The quarterly dividend comes to $0.68 per share annually, bringing the current dividend yield to 0.53%. While EA's dividend yield is lower than the S&P 500 average yield of 1.56%, it is on par with rival Activision Blizzard's current yield of 0.52%.
With 293 million diluted shares outstanding, EA's annual paid dividend amount should come to $199 million that will be distributed to shareholders over the next four quarters.
Along with the dividend, EA also announced a two-year share repurchase program totaling $2.6 billion, representing 7% of EA's current market capitalization (total shares outstanding times the share price). EA expects to return a total of $3 billion through dividends and share buybacks over the next 24 months.
Investors should expect a growing dividend over the long term. EA generates plenty of cash to fund a rising dividend payout, especially considering that EA's declared dividend comes to only 11% of the $1.7 billion in free cash flow that management expects the business to produce in fiscal 2021.
Moreover, EA has substantially improved its free cash flow production over the last 10 years, so it's reasonable to expect the dividend to rise in tandem over time.
EA already has $5.9 billion of cash and short-term investments sitting in the bank with very little debt. Video game companies only need to spend small sums on capital expenditures to fund operations, which is why EA can build such a large cash hoard.
What's more, EA is in a better financial position than Activision Blizzard, which currently has $3.6 billion of long-term debt it must pay down. Activision first initiated a dividend in 2010 and has increased it every year since. With plenty of cash on the books and plenty of free cash flow pouring in every year, EA should be a great dividend growth stock too.
Why is EA so cash-rich?
Most of EA's revenue is derived from digital sales of full-game downloads, in-game content, and subscriptions. Only 14% of total revenue came from sales of packaged goods, such as physical game discs, over the last four quarters.
As with other entertainment markets, gamers were already shifting to digital purchases before the pandemic, but the trend accelerated this year, with sales of packaged games plummeting in recent quarters. Although EA values its relationships with retail partners, more sales coming through digital channels is good for EA's business, since digital sales tend to generate a higher gross profit margin.
EA's gross margin has also been trending in the right direction for the last 10 years.
EA's live service net bookings, which include in-game spending for digitally delivered content, grew 28% in the first half of fiscal 2020. It's becoming the biggest driver of growth for EA, with live services reaching $3.9 billion in bookings on a trailing 12-month basis. That's an increase of $515 million year over year.
The most popular live service for EA is Ultimate Team in its sports titles. With Ultimate Team, players in Madden NFL 21 and FIFA 21 purchase digital cards to personalize their team to take online and compete with other players. Over the last three fiscal years, Ultimate Team revenue has been growing, comprising 27%, 28%, and 23% of EA's total revenue.
Specifically, EA Sports Ultimate Team currently has more than 30 million players, an increase of 25% over last year. It's not only growing, but most importantly, these players tend to come back every year and buy the new version of Madden or FIFA, which is why EA considers its live services business to be a recurring revenue stream. This likely played a factor in management's decision to initiate its first dividends.
Is the dividend a buy signal?
EA has got several new releases coming next year that will take advantage of the fancy technology of the new game consoles that just launched in November from Sony and Microsoft. One of these will be the next installment in the Battlefield series, which is a catalyst for growth in fiscal 2022.
While I wouldn't buy this top gaming stock simply because of the dividend, investors should look at this announcement as a positive signal about where management sees the business headed over the next decade. With continuing growth in live services and opportunities to reach new audiences on the new game consoles, Electronic Arts is headed in a lucrative direction.