I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.
Next up: Electronic Arts
|CAPS rating (5 max)||**|
|Bullish pitches||359 out of 414|
|Highest rated peers||
Shanda Games, Giant Interactive, Activision Blizzard
Data current as of Dec. 11.
Fools don't see much value in Electronic Arts compared to peers. Activision Blizzard gets four of five possible stars in CAPS versus just two for EA. Take-Two Interactive
"Though FIFA is doing well, between handing market share to [Take-Two] by delaying (and perhaps cancelling) NBA Live, and the poor execution behind [Medal of Honor], this next quarter's call is going to be really disappointing -- these two missteps likely cost them $200M in revenue. I believe in [Electronic Arts] long-term (they're just too big and diversified to fall apart), but $16.76 is a bad price. We'll see what happens after earnings," wrote Foolish investor mugwump67 in mid-October.
Talk about prescient. Shares of EA are down more than 5% since that call, due at least in part to a disappointing performance for Medal of Honor, which was October's third-best-selling title despite a ton of buildup.
Investors also didn't much care for the quarterly report issued in early November. Apparently, they were looking for more than market-beating results, which they got. They were also looking for higher guidance, which they didn't get.
The elements of growth
Last 12 Months
|Normalized net income growth||Not measurable||Not measurable||Not measurable|
|Shares outstanding||332 million||329.6 million||322.8 million|
Source: Capital IQ, a division of Standard & Poor's.
Does that mean EA has been the victim of an unreasonable sell-off? Don't be too sure. The company's financials aren't exactly brimming with growth. Let's review:
- Revenue isn't declining as sharply as it once was, and net losses were lower than expected last quarter. Sure, this is good news, but only because it could've been worse.
- In better news, cost cuts have allowed EA to make big gains in gross margin. Cost of good sold is down 28% over the past two years. Revenue is down 13% over the same period.
- Even so, cash isn't flowing nearly as much as I'd like. In each of the past two years, EA has burned cash instead of creating it. While the trend's reversed itself over the past 12 months, the damage is already done: EA has issued shares in order to fund growth, diluting existing owners.
Competitor and peer checkup
Normalized Net Income Growth (3 yrs.)
|Activision Blizzard||Not available|
|Electronic Arts||Not measurable|
|Take-Two Interactive||Not measurable|
Source: Capital IQ, a division of Standard & Poor's. Data current as of Dec. 11.
Reading this table, I can't help but smile. EA's well-known franchises haven't given it any kind of edge over most rivals in terms of normalized net income. Instead, it's Microsoft that comes across as the class act of the group.
That's unlikely to change soon. Mr. Softy has scored a big hit with the Kinect controller and has a strong franchise of its own in the Halo series for Xbox.
Call me a pessimist if you must, but I don't see how EA's advantages translate into premium growth or a premium valuation. I'd be more likely to short the stock than own it, now that it's trading for more than 20 times forward earnings.
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Microsoft is a Motley Fool Inside Value pick. Take-Two Interactive is a Motley Fool Rule Breakers recommendation. Activision Blizzard and Electronic Arts are Motley Fool Stock Advisor selections. Motley Fool Options has recommended subscribers open a synthetic long position in Activision Blizzard and a diagonal call position in Microsoft. Try any of our Foolish newsletter services free for 30 days.
Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Activision Blizzard, Microsoft, and Take-Two Interactive. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.